Contemporary Issues in Islamic Social Finance [1 ed.] 9780367505202, 9780367505233, 9781003050209

Citation preview

CONTEMPORARY ISSUES IN ISLAMIC SOCIAL FINANCE

The development of Islamic banking and finance (IBF) previously centred around three regions of the world: the Middle East, Southeast Asia, and South Asia. However, in recent years, this has expanded, as interest in IBF has gained momentum in Australia, the USA, and Europe, especially in the UK. Several Western market players have established their own Islamic window or subsidiaries to cater to the need of growing Muslim populations in these regions. This book examines the recent developments in IBF, particularly in the context of Islamic social finance instruments, such as Islamic microfinance, halal education, takaful, mutual funds, and waqf. It covers the religiosity, spirituality, and tawhid index, which promotes social well-being and empowerment. The book is interdisciplinary, and theories, practice, and key issues are presented simultaneously, introducing new ideas and techniques to the IBF community. Moreover, the book examines topics such as innovation in Islamic social finance instruments, advanced techniques of risk mitigation in Islamic capital markets, marketing and the halal industry, and shari’ah-compliant instruments, which are critical to Islamic finance. The book is an essential reference text for academics and research students at the master’s and doctorate levels in IBF. Hussain Mohi-ud-Din Qadri is Deputy Chairman of the Board of Governors of Minhaj University, Lahore, and Associate Professor at the School of Economics and Finance, Minhaj University, Lahore, Pakistan. M. Ishaq Bhatti is a Professor of Finance and Financial Econometrics and the Founding Director of the Islamic Banking and Finance Programme at Latrobe University, Australia.

ISLAMIC BUSINESS AND FINANCE SERIES Series Editor: Ishaq Bhatti

There is an increasing need for western politicians, financiers, bankers, and indeed the western business community in general to have access to high quality and authoritative texts on Islamic financial and business practices. Drawing on expertise from across the Islamic world, this new series will provide carefully chosen and focused monographs and collections, each authored/edited by an expert in their respective field all over the world. The series will be pitched at a level to appeal to middle and senior management in both the western and the Islamic business communities. For the manager with a western background the series will provide detailed and up-to-date briefings on important topics; for the academics, postgraduates, business communities, manager with western and an Islamic background the series will provide a guide to best practice in business in Islamic communities around the world, including Muslim minorities in the west and majorities in the rest of the world. ISLAMIC FINTECH Edited by Sara Sánchez Fernández ISLAMIC FINANCIAL CONTRACTS A Research Companion Hussain Mohi-ud-Din Qadri and Nasir Iqbal BENCHMARKING ISLAMIC FINANCE A Framework for Evaluating Financial Products and Services Edited by Mohd Ma’Sum Billah CONTEMPORARY ISSUES IN ISLAMIC SOCIAL FINANCE Edited by Hussain Mohi-ud-Din Qadri and M. Ishaq Bhatti For more information about this series, please visit: www.routledge.com/ Islamic-Business-and-Finance-Series/book-series/ISLAMICFINANCE

CONTEMPORARY ISSUES IN ISLAMIC SOCIAL FINANCE Edited by Hussain Mohi-ud-Din Qadri and M. Ishaq Bhatti

First published 2022 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 605 Third Avenue, New York, NY 10158 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2022 selection and editorial matter, Hussain Mohi-ud-Din Qadri and M. Ishaq Bhatti; individual chapters, the contributors The right of Hussain Mohi-ud-Din Qadri and M. Ishaq Bhatti to be identified as the authors of the editorial material, and of the authors for their individual chapters, has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Names: Qādrī, Ḥusain Muḥīuddīn, editor. | Bhatti, M. Ishaq, editor. Title: Contemporary issues in Islamic social finance / edited by Hussain Mohi-ud-Din Qadri and M. Ishaq Bhatti. Description: 1 Edition. | New York : Routledge, 2021. | Series: Islamic business and finance | Includes bibliographical references and index. Identifiers: LCCN 2021007629 (print) | LCCN 2021007630 (ebook) Subjects: LCSH: Finance—Religious aspects—Islam. | Finance (Islamic law) | Banks and banking—Religious aspects—Islam. | Sharing—Religious aspects—Islam. | Social responsibility of business—Islamic countries. Classification: LCC HG187.4 ,C656 2021 (print) | LCC HG187.4 (ebook) | DDC 332.0917/67—dc23 LC record available at https://lccn.loc.gov/2021007629 LC ebook record available at https://lccn.loc.gov/2021007630 ISBN: 978-0-367-50520-2 (hbk) ISBN: 978-0-367-50523-3 (pbk) ISBN: 978-1-003-05020-9 (ebk) DOI: 10.4324/9781003050209 Typeset in Times New Roman by codeMantra

CONTENTS

ix xi xiii xxiii

List of figures List of tables List of contributors Foreword 1 Contemporary issues in Islamic social finance

1

HUSSAIN M. QADRI AND M. ISHAQ BHATTI

2 Implications of profit-sharing investment accounts on the capital structure of the Islamic bank: a comparative study

10

JOHAINA K HALID AND DAWOOD ASHRAF

3 Tawhid index of global well-being as the principal indicator of spirituality and development

24

MASUDUL ALAM CHOUDHURY

4 Risk management and risk sharing in Islamic finance: theory and practice

36

RODNEY W ILSON

5 Debt, risk, and Islamic moral economy

55

TOSEEF A ZID, OSAMAH H. AL RAWASHDEH, AND MUHAMMAD OMER CHAUDHRY

6 Role of the State Bank’s policy rate in Pakistan’s economy

72

ATIQ UR REHMAN

7 Religion, culture, and Islamic marketing HUSSAIN MOHI-UD -DIN QADRI

v

87

CONTENTS

8 A theoretical model for job creation: the role of banks

107

AN WAR SHAH

9 Lessons from the UK’s dedicated Islamic banks

119

MOHAMMED AMIN

10 Inclusive and sustainable growth with Islamic finance

150

SALMAN AHMED

11 Embracing Islamic banking as a new engine toward economic growth

169

SYED MUHAMMAD ABDUL REHMAN SHAH, MUHAMMAD UMAR FAROOQ, AND MUHAMMAD AKMAL

12 The role of zakat in addressing poverty: an analysis of Sokoto state Zakat and Waqf (Endowment) Commission

185

AMINU ALHAJI BALA

13 Analyses of sources and uses of charity fund account: a case study of “Meezan” bank

193

MOHAMMAD AYA Z , K HURRAM FAISAL JAMAL, AND SADAF SHAHEEN

14 Issuance of musawwamah-based card by Islamic banks as an alternative to credit card: opportunities, challenges and prospective solutions

207

IMAM UDDIN, MUHAMMAD SHUJAT SALEEM, AND ABDUR RAHMAN ALEEMI

15 The socio-economic impact of waqf in Islam: a study of the Zakat and Endowment Commission in Sokoto state, Nigeria

226

MUHAMMAD DAHIRU SHU NI

16 Business zakat reporting: evidences from the Islamic financial institutions

234

TEH SUHAILA TAJUDDIN AND IZLAWANIE MUHAMMAD

17 The blueprint of pre-higher education program: a platform to uplift the B40 economic position through Islamic social finance AINI JA PAR, SITI SALWA SALLEH, MA ZLINA MAHDZAR AND AHMAD SHAHRIL A Z WAN ABDUL RAHIM

vi

246

CONTENTS

18 An increasing demand for halal products and services: a call for the enactment of an international convention on halal industries

260

IBRAHIM DANJUMA

19 Education for young generations on halal food audit and certification: challenges and future prospects

273

HADIA SAQIB HASHMI AND HASSNIAN ALI

20 Optimizing halal tourism in Indonesia to accelerate economic growth

293

SHIN TA MAHARANI

21 Doing the best by providing quality services: a study of the relationship between Islamic banking and customer behavior

312

SHAHBA Z AHMED, MUHAMMAD ASHFAQ, RAB NAWA Z LODHI, AND RASHEDUL HASSAN

22 Green sukuk for financing renewable projects in Islamic social finance: problems and solutions

331

MARYAM SAEED

23 Conclusion on contemporary issues in Islamic social finance

347

HUSSAIN M. QADRI AND M. ISHAQ BHATTI

349

Index

vii

FIGURES

3.1 Tawhidi Methodological Worldview Contrasted with Shari’ah in Practice 3.2 Spiritual θ-Embedded Development Indices and Organizational Inter-causal Indices Derived from the Objective Criterion of Evaluating the Well-being Criterion 6.1 Foreign Direct Investment in Pakistan 2010–2019 6.2 Foreign Exchange Reserves in Pakistan 2011–2019 6.3 YoY Inflation in Pakistan 2009–2019 6.4 YoY Inflation in the US 2005–2020 8.1 Graphical presentation of the services delivery model 9.1 Many Muslims are Outside the Addressable Market 10.1 Islamic Financial System 10.2 Equilibrium in the Interest-Free Asset Market 10.3 Downward Shift in the SDU Curve 10.4 Upward Shift in the SDU Curve 10.5 Rightward Shift in the SSU Curve 10.6 Leftward Shift in the SSU Curve 10.7 Islamic Banks in Inclusive Islamic Economics Framework 11.1 Expected Islamic Assets Globally 17.1 Distribution of students across Malaysia between 2010 and 2018 17.2 State Campuses and Pre-Diploma Program 17.3 The Four Pillars of the PPT Framework 17.4 The Blueprint Framework of the UiTM PPT 19.1 Process of Halal Certification 20.1 Framework 20.2 Factors Affecting the Decision of Muslim Tourists 20.3 Halal Tourism Destinations 20.4 Respondents’ Gender 20.5 Respondents’ Hobbies 20.6 The Respondents’ Gender 20.7 The Respondents’ Age

ix

26 33 76 76 77 78 114 141 152 154 155 155 156 156 161 170 253 254 255 256 280 293 294 295 297 297 301 301

F igures

20.8 The Parent Works 20.9 Respondents Based on Their Hobbies 20.10 The Times of Visits to Halal Tourism Destinations 20.11 Information 21.1 Theoretical Framework 21.2 Direct Effect of Service Quality (Model 1) 21.3 Indirect Effect of Service Quality (Model 2) 22.1 Investment of Green Sukuk in Renewable Projects

x

302 302 303 304 318 323 324 338

TABLES

2.1 2.2 2.3 2.4

Descriptive Statistics for Conventional and Islamic Banks Capital Structure of Islamic and Conventional Banks Correlation Matrix between Market Value and Total Deposits Estimation Results on the Impact of Deposits on the Market Value, Earning per Share and Cost of Equity of Islamic Banks 4.1 Risk-Weighted Assets (AED’000) 4.2 Capital Ratios 4.3 Risk-Weighted Assets (RWA) and Capital Requirements (CR), (RM’000) 5.1 Hope and Expectations 6.1 Correlation between the Three-Month Treasury Bill Rate and YoY Inflation for the US in the Past Six Decades 6.2 Correlation between Inflation and Lagged Interest Rate in the US 7.1 Internet and Social Media Users in Muslim Countries 9.1 Conventional and Islamic Finance Terminology 9.2 Results of EIIB from Calendar 2005 9.3 European Islamic Investment Bank Executives 2005–2018 9.4 The Annual Results of the Bank of London and the Middle East plc 2007–2018 9.5 Financial Summary of Gatehouse Bank plc (2007–2018) 9.6 Financial Summary of QIB (UK) plc (2007–2018) 9.7 Financial Results of Al-Rayan Bank plc (previously Islamic Bank of Britain plc) 2007–2018 9.8 Financial Summary of ADIB (UK) 2012–2018 9.9 Changes in Management of ADIB (UK) 2012–2018 9.10 Summary of Financial Results 9.11 The 2011 Census for England and Wales Depicting the % Age of Young Muslims 10.1 Growth in Islamic Banking and Finance (2012–2017)

xi

16 17 17 19 47 47 48 63 78 79 91 120 124 125 126 129 130 132 136 137 138 141 158

T ables

10.2 10.3 10.4 10.5 11.1 11.2 11.3 11.4 11.5 13.1 13.2 16.1 16.2 17.1 19.1 19.2 19.3 19.4 19.5 19.6 20.1 20.2 20.3 20.4 20.5 21.1 21.2 21.3 21.4 21.5

Share of Countries in Global Islamic Banking Assets Islamic Banking Indicators Globally Aggregate Demand Stimulants in Islamic Finance Use of Islamic Finance in Sustainable Development Goals Description of Variables Descriptive Statistics ADF Test Results Results of Ordinary Least Square (OLS) Granger Causality Results Statement of sources and uses of the CFA of “Meezan” Bank 2014–2019 Statement of the CFA’s disbursement Principal Activities and Statement on Zakat Obligation by Different IFIs Disclosure of Zakat Items Generic Parameters and Their Utility Growth of the Halal Industry Population and Technology Adoption in OIC Countries Number of Muslims in Western Countries Number of Certification Bodies in the World Educational Programs Related to Halal Industry at Different Institutions Halal Education for Halal Logistics and Supply Chain Halal Tourism in Indonesia (Prior Study, September 2018) Nature of Tourism Halal Tourism Validity Test Results Reliability Test Results Model Summary The Demographic Characteristics of the Customers The Factor Loadings and Cronbach Alpha for Measuring Constructs Fit Indices in the Confirmatory Factor Analysis of Service Quality, Customer Satisfaction, and Loyalty Behavior Correlation Coefficients Testing the Effect Size Using R Square

xii

159 159 162 165 176 177 177 178 180 199 199 240 243 251 275 277 278 279 283 288 296 304 305 305 306 320 321 322 322 324

CONTRIBUTORS

Salman Ahmed holds a PhD in economics from National University of Malaysia and a master’s degree in economics from the Institute of Business Administration, Karachi. Dr. Salman has published a considerable number of papers in well-reputed international journals. Most of his papers have been published in SSCI, Scopus, and ERA indexed journals. His number of book chapters are published by Web of Science publishers. He has presented his research works in various international conferences in Turkey, Malaysia, Japan, Brunei, Indonesia, and Pakistan. He received two Emerald Highly Commended Paper Awards in 2018. He is currently serving as Editorial Advisory Board Member of Emerald IJIMEFM (SSCI) and also working as editor of Moral Reflections on Economics published by Islamic Economics Project. Shahbaz Ahmed is a management science graduate from the University of Veterinary and Animal Sciences, Lahore. His computing expertise on statistical software has been used to analyse big data using SPSS, Smart PLS, MINITAB, AMOS, STATA, MPLUS, thematic tool, and NVIVO. His research on quality servicing is well known including the service quality performance in Islamic Banking, which is one of the specialized areas of the banking and finance industry. Muhammad Akmal is a PhD scholar in Islamic Banking and Finance and Manager Shari’ah Compliance in MCB. His primary responsibility is to ensure Shari’ah compliance at all levels, specifically Pool Management and Branch/Department Review. Moreover, he is responsible for Shari’ah trainings on Islamic Banking in coordination with learning department. His research work includes Takaful i.e. Islamic mode of insurance, Islamic microfinance, and Islamic banking, published in national and international journals. Abdur Rahman Aleemi is working as assistant professor and research consultant at the Institute of Business Management, Karachi. He holds a PhD in business management and an M.Phil. in finance. His main xiii

contributors

research interests are in financial economics, Islamic finance, banking regulations, supervision, and stability. He is also a lead researcher in the areas of banks’ charter value, market power, franchise value, market structures, and market discipline. Hassnian Ali is a graduate with a master’s degree in Islamic banking and finance and has currently undertaken his PhD at the International Center of Education for Islamic Finance, Malaysia. He is also working as assistant director of Research at the International Center for Research in Islamic Economics at Minhaj University in Lahore. He is one of the pioneer researchers and has authored a book in the area of Islamic Fintech. He has presented numerous research papers on Fintech in combination with Islamic finance at international workshops and conferences. Hassnian is an upcoming scholar who will play a crucial role in Islamic Fintech in the years ahead. Mohammed Amin is a UK-based Islamic finance specialist who focuses on how Islamic finance is treated in Western tax and regulatory systems. Until he retired at the end of 2009, he led PricewaterhouseCoopers’ (PwC) Islamic Finance practice in the UK as well as being a member of PwC’s four-person Global Islamic Finance Leadership Team. Apart from PwC, he has had been an (i) original member of the HM Treasury Islamic Finance Experts Group, established by the Economic Secretary to the Treasury in April 2007 to advise the Government on Islamic Finance strategy. He was the only practicing accountant on that group, (ii) Member of the Editorial Advisory Board of “New Horizon”, the magazine of the Institute of Islamic Banking and Insurance, (iii) Member of the Editorial Advisory Board of the International Journal of Islamic and Middle Eastern Finance and Management, and (iv) the Member of the Islamic Finance for Business Working Group set up jointly by International Financial Services London and British Expertise. Amin  regularly contributes articles and book chapters on Islamic finance to a range of professional and industry publications. In particular, he wrote the Alternative Finance Arrangements (Islamic Finance) section of Simon’s Taxes, which is the leading tax encyclopedia in the UK. In 2011, WikiLeaks revealed that in early 2009 the American ambassador had quoted him in a cable to the State Department. He was the lead researcher and principal author of the report “Cross border taxation of Islamic finance in the MENA region Phase One”, which was published on 13 February 2013 by the Qatar Financial Centre Authority. For over four years he has written a monthly column in the magazine “Islamic Finance News.” Muhammad Ashfaq holds a PhD from Tübingen University. He is working as a Professor of Finance and Accounting at International University of xiv

contributors

Applied Sciences in Germany. He is the Programme Director of Digital Business. His research interests include Islamic Finance, Digital Transformation, and FinTech. Muhammad is a trainer and consultant, and is the Chief Executive of Amanah IIFE, an ethical banking and Islamic finance consulting firm based in Germany and Pakistan. He is the author of various research articles and has attended and spoken at several national and international conferences in more than 25 countries. He is an established writer and has contributed several chapters in different books, and co-edited a book on the topic of finance, ethics, and Islamic banking. Dawood Ashraf  is a Senior Research Economist at Islamic Development Bank (IsDB) based in Jeddah, Saudi Arabia. He holds a Ph.D. in Banking and Finance from the University of Wales (now Bangor University). He is also a charter holder and member of the CFA Institute. Dr. Ashraf’s research interests are in sustainable ethical finance, portfolio management, banking, corporate finance, and artificial intelligence application in finance. He published in several international journals, including Journal of Financial Stability, Journal of Business Ethics, and European Journal of Finance. He is also a subject editor of Emerging Markets Review and Journal of International Financial Markets, Institutions and Money. At IsDB he has led teams to produce several vital reports on the policy side, including the first two editions of the Global Report on Islamic Finance, the impact of Covid-19 on Islamic finance and the artificial intelligence to harness financial inclusion. Mohammad Ayaz is currently working as Associate Professor at the Department of Banking and Finance, University of Management and Technology (UMT). He did his PhD and LLM in Islamic Banking and Finance from International Islamic University, Islamabad. His area of interest is Islamic Microfinance and Shariah Governance in Islamic Financial Institutions. Toseef Azid is a Professor of Economics in the college of Business and Economics at the University of Qassim (UoQ), Saudi Arabia. He obtained his master’s degree in Quantitative Economics and a PhD in Economics (University of Wales, Aberystwyth). Prof Toseef has 32 years’ experience in teaching at the university level in different parts of the world and research experience in forecasting models, development economics, and Islamic economics. His professional career began as a research associate in the Gallup Poll of Pakistan and then followed by Professorship at BZ University, Multan. He then served as an academic at various universities before moving to UoQ in Saudi Arabia. He also worked as a resident scholar in El Camino Community College, Los Angeles, USA and as a professor of Economics at Taibah University, Madinah, Kingdom xv

contributors

of Saudi Arabia. He is author of three books and more than 50 articles in international journals. His research was presented in international conferences held in Canada, Australia, Iran, Bahrain, Indonesia, China, Malaysia, Pakistan, and Saudi Arabia. One of his papers entitled “The Role of Technology Spillovers in Convergence” won Emerald Literati Network 2011 Awards for Excellence. Aminu Alhaji Bala is associate professor of Da’wah and former Head of Department of Islamic Studies, Faculty of Arts and Islamic Studies, Usmanu Danfodiyo University, Sokoto, Nigeria. Being the Head of Department, he has administered undergraduate, MPhil, and PhD programmes in Islamic Studies. Dr. Aminu Bala holds a PhD in Islamic studies and a master’s in public administration. He has presented several research papers and published articles in peer-reviewed, open access, and indexed national and international journals. He is currently the Chairman, Nigerian Association of Teachers of Arabic and Islamic Studies, Sokoto State Chapter. Dr. Aminu has visited Niger Republic, Saudi Arabia, Pakistan, and Malaysia for academic purposes. M. Ishaq Bhatti  is professor of finance and financial econometrics at Latrobe University. He is author of more than 120 articles and 8 books; he has contributed to encyclopedias, and he is a member of the editorial board of various international journals, including the European Journal of Finance. His major areas of research and teaching are in data analytics and quantitative and Islamic finance. His contribution to teaching excellence has been recognized with several teaching awards at the university and national levels—including an ALTC award. He was a member of the team that won Turkey Central Bank Training 2013, Islamic Development Bank, the AARC discovery grant jointly with Suren Basov and Saudi capital Market’s—Mutual Fund project with Naseem Al Rahahleh. He is currently editing Routledge’s ‘Islamic Business and Finance’ book series: https://www.routledge.com/Islamic-Business-and-Finance-Series/ book-series/ISLAMICFINANCE and Associate editor of the Journal of International financial markets, Institutions & Money, and the European Journal of finance. Muhammad Omer Chaudhry is associate professor at Bahauddin Zakariya University, Multan, Pakistan. He holds a PhD in logistics/supply chain management with specialization in transport economics from Molde University College, Norway. Dr. Chaudhry has also completed his MSc in logistics from the same college, and MPhil from BZU, Multan. He has published several academic papers in national and international journals. He has also presented a number of papers at various international conferences in different countries. His research focus is mainly on religious economics. xvi

contributors

Professor Masudul Alam Choudhury  is currently working as Professor & Dean Faculty of Business Administration at University of Science and Technology Chittagong, Bangladesh. He is also working as the International Chair, Postgraduate Program of Islamic Economics & Finance Faculty of Economics, Trisakti University, Jakarta, Indonesia (https:// www.ief-trisakti.ac.id/). Prior to this, he worked at the Sultan Qaboos University, Muscat, Sultanate of Oman and taught economics for 22 years in Cape Breton University, Sydney and Nova Scotia, Canada before his retirement. He now continues to conduct advanced research and teaches at all levels of pedagogy. His research areas of focus and teaching at the doctoral level are economics and epistemology of unity of knowledge, and its functional ontological conceptualization and application to the world-system in diverse areas. In this domain are included political economy, economic theory, financial issues, and integral relations between science and society. His methodological approach is system-oriented and mathematical while invoking philosophy of science and empirical application. Professor Choudhury has published profusely in refereed journals and many books with leading scholarly publishers. His above-mentioned focus has prevailed in all such academic outlets. He got 270 publications with thousands of citations including a latest book on Covid 19, which was published by Routledge in 2021. Dr Ibrahim Danjuma  is currently working as head of Public Law Department, in the Faculty of Law, Bauchi State University Gadau, Nigeria. He is an active researcher and one of the best award-winning teachers at the universities. His research appeared in local and international journals and he has been presenting his research at various international conferences representing his country. He is an excellent teacher, researcher, and educationist with added administrative expertise in academic institutions. Muhammad Umar Farooq  is assistant professor at Government College University Faisalabad, Pakistan. He holds a PhD in Western Economics from Shandong University, Jinan, China. His area of interest is macroeconomics, microeconomics, energy economics, mathematical economics, and Islamic economics. His research articles are published in the Social Sciences Citation Index, Web of Sciences journals, and in some well-known nationally recognized journals. Hadia Saqib Hashmi is working as research assistant while undertaking her postgraduate studies at Minhaj University Lahore (MUL) in the field of Islamic banking and finance. Prior to joining MUL, she completed her seven years’ degree of Shahadat ul Almiyyiah at Minhaj College for Women. She is one of the youngest researchers in women entrepreneurship vis-a-vis Islamic finance. She has presented her research findings at numerous international conferences on the topic of Fintech, Islamic xvii

contributors

education for young females, global halal industry, and economic advancements. Dr Rashedul Hassan  is lecturer in accounting at Coventry University, United Kingdom. Rashedul completed his PhD in 2018, focusing on corporate governance issues for a non-profit organization. He is also a CIMA member and holds the designation ACMA, CGMA. His research interest includes corporate governance dynamics, performance, and risk management aspects of financial institutions, sustainability, and accountability issues. Rashedul serves as associate editor of the Journal of Economics. He has been publishing his research theses in ABS, ABDC, and SCOPUS indexed accounting and finance journals. Khurram Faisal Jamal  is a PhD scholar at UMT. Before joining UMT he acquired an MS degree in Islamic finance from University Utara Malaysia. He has more than ten years of academic experience with several publications to his credit. His current research interests include Islamic banking and Islamic microfinance with a particular emphasis on its multiple products and their role in alleviating poverty in Pakistan. Aini Japar is associate professor at the Centre of Studies for Quantity Surveying, Faculty of Architecture, Planning and Surveying, UiTM Shah Alam, Selangor. She is also director at Pre-Higher Education Programme since 2017. She obtained a PhD in value management from Universiti Teknologi MARA, and since then she has been working as an academic with a solid research and publication record. Johaina Khalid is currently working as a lecturer in the Institute of Management Studies at University of Peshawar, Pakistan. She graduated with a master of business administration degree, majoring in finance from the same university before proceeding to obtain an M Phil degree from National University of Sciences and Technology, Pakistan. Her areas of interest in research are Islamic finance and practices of Islamic banks. She is the author of a couple of papers and has also presented her research in a few international conferences. Rab Nawaz Lodhi is associate professor of management at the University of Central Punjab, Lahore, Pakistan. He is a visiting research scholar at M3 Center of Muma College of Business, University of South Florida, USA. He has vast teaching, training, and research in Pakistan, Malaysia, Turkey, Kazakhstan, the Netherlands, Indonesia, Philippines, Saudi Arabia, and in the USA. He is author of 45 research publications and a guest editor of Journal of Hospitality and Tourism Technology. He is an international trainer of quantitative and qualitative research methodologies, mixed methods design, and data analytical tools, e.g., NVivo, MaxQDA, Atlas-ti, SPSS, STATA, AMOS, Smart PLS, and Mplus. xviii

contributors

Shinta Maharani is currently working as assistant professor in the Faculty of Economics and Islamic Business, The State Institute of Islamic Studies Ponorogo, in Indonesia. Her research expertise is in the areas of Islamic finance, Islamic marketing, halal finance, and halal tourism. She widely publishes and presents her research in conferences and invited seminars. Mazlina Mahdzar is senior lecturer at the Department of Tourism Management in the Faculty of Hotel and Tourism Management, Puncak Alam Campus, UiTM Selangor, Malaysia. She is Head of the Academic Unit at Pre-Higher Education Programme, UiTM Shah Alam, Selangor. After obtaining her PhD, she has been part of the academia with the highest performance in all areas of academic accomplishment. Izlawanie Muhammad is associate professor in Universiti Sains Islam Malaysia (USIM). She joined USIM since 2008 and obtained her PhD (Taxation) from the University of New South Wales, Australia. She is also a Member of the Association of Certified Chartered Accountants, a Chartered Accountant of the Malaysian Institute of Accountants, and a Fellow Member of Malaysian Tax Institute of Malaysia. Prior to joining USIM, Dr. Izlawanie had more than six years of work experience with the Inland Revenue Board of Malaysia and Bumiputra-Commerce Bank Berhad (now known as CIMB Bank). She is an active researcher and has obtained several research grants from the Ministry and industries. Her research interests are tax administration, zakat, and environmental tax. She has published and presented research papers in international conferences held in Malaysia and overseas including Maldives, Australia, Turkey, and the United Kingdom. Hussain Mohi-ud-Din Qadri  is associate professor and the Deputy Chairman of the Board of Governors of Minhaj University Lahore in Pakistan. Dr. Qadri has published a number of articles in internationally reputed journals and books including in the Islamic business and finance series published by Routledge. Dr. Qadri’s contribution is widely noticeable in both academic and nonacademic circles of Pakistan. Dr Qadri has also been serving as President of Minhaj-ul-Quran International; Chairman Minhaj Education Society (running 650 schools and colleges all over Pakistan); Chairman Aghosh Orphan Care Homes; Chairman Al-Mawakhat Islamic Microfinance and Chairman Minhaj Halal Certification Pakistan. He is an adjunct researcher and Honorary at the University of Melbourne (UoM), Australia where he won a highly competitive Australian Research Council (ARC) discovery grant jointly with Professor Abdullah Saeed of UoM in 2020. Ahmad Shahril Azwan Abd Rahim is assistant registrar at the Pre Higher Education Programme, UiTM Shah Alam, Selangor, Malaysia since the past ten years. Ahmed has been actively involved in the process of student’s xix

contributors

applications, enrollment, and promotion programme. This chapter is one of the examples of his active work in research based on real life data. Osamah Hussien Al Rawashdeh  is associate professor in the College of Business and Economic at UoQ and director of the AACSB Office. He has more than 25 publications and presented his research in various international conferences. His research interest is in corporate finance, credit management, banking, and non-banking systems. He possesses a wealth of knowledge in financial theory of teaching. Dr. Rawashdeh is a well-known academician and has served in various academically viable committees as director of financial program, Director of Curriculum Development Committee, and Revising and Developing Curriculum. Atiq ur Rehman is associate professor and director at Kashmir Institute of Economics, University of Azad Jammu and Kashmir (UAJK). Before joining UAJK, he has been serving at Pakistan Institute of Development Economics and International Institute of Islamic Economics, International Islamic University. He earned his PhD in econometrics from International Islamic University, Islamabad. He is primarily trained in econometrics. Dr. Rehman has developed skills in a variety of economicsrelated disciplines, including econometrics, monetary economics, development studies, health economics, and Islamic banking and finance. His academic contributions are in publishing several reputed economic journals including Journal of Central Banking and Applied Economics. He translates the abstract economic concepts to simple and lucid language for ordinary readers; therefore, his blogs and newspaper articles are well received by people from a non-economic background. He writes frequently in the Express Tribune, Pakistan Observer, Parliament Times, and other periodicals published in Urdu language. He is an active participant in policy dialogues, especially on monetary policy and has presented his views in national and international forums. Maryam Saeed  is a PhD scholar at the University of management and technology in InsurTech in Pakistan. Her MSBA thesis is published as a research paper in the emerald International journal of Journal of Economics, Finance and Administrative Science. She authored three more papers other than her PhD thesis in the area of human resources in the HR department of SNGPL, head office, Lahore and HR department of PC Hotel, mall road, Lahore and has one year work experience as Dean Assistant in Kinnaird College. Her research expertise is in insurTech, fintech, takaful and the Islamic capital market. Muhammad Shujat Saleem is working at Mohammad Ali Jinnah University since 2007. He is an active researcher in the field of comparative study in conventional and Islamic finance. He is a winner of the Best Paper Award from the Islamic Development Bank in the 2nd International Conference xx

contributors

on Islamic Economics, Banking and Finance 2019. He started his career as banker from Citi Bank in the credit initiation unit of Mortgages. He appeared in media in Malaysia and Pakistan and has authored various journal articles while completing his studies at the University of Malaya. Besides an MBA degree from the Institute of Business Administration, Karachi, he received a diploma in Islamic banking from Jamia’ Darul Uloom, Karachi. Siti Salwa Salleh is senior lecturer in Faculty of Computer and Mathematical Sciences, University Technology MARA (UiTM), Seremban Campus in Malaysia. She obtained her PhD in Computer Vision and Imaging from Univerisity Putra, Malaysia. Her research focuses on big data, developing a computer model to facilitate learning for hearing-impaired children in a classroom. She is the winner of 18 awards including a Premier Award in Teaching and Learning in 2017. Anwar Shah is associate professor in the School of Economics at Quaid-iAzam University (QAU), Islamabad, Pakistan. Dr. Anwar has obtained his PhD in economics from the University of Melbourne, Australia. Dr. Anwar is also an alumnus of the International Islamic University, Islamabad where he received his first degree and later obtained his MPhil from QAU. He has published his research works in the Journal of Economic Behavior and Organisation and Pakistan Development Review. His research interests are in Islamic economics and finance, behavioral and experimental economics, cooperation, social issues, and organizational efficiency. He has presented his work at various forums nationally and internationally. He is also working on some applied projects related to philanthropy and support of students and have initiated a business based on the model of an informal Ballot committee. Syed Abdul Muhammad Rehman Shah is assistant professor at the University of Engineering and Technology (UET) Taxila. Dr. Syed is PhD and MS in Islamic Banking & Finance from International Islamic University Islamabad, Pakistan, Dr. Syed has also obtained his shahada tul Alimia (Dars e Nizami) from DMG Bhera, Sargodha, and has an MA in Islamic Studies from the University of Sargodha, Pakistan. He has published more than 17 papers and 5 book chapters and conference proceedings. He has also presented his research in Kazakhstan, Turkey, Sudan, Indonesia, and at the Al-Azhar University, Cairo, Egypt. Sadaf Shaheen is a PhD scholar on Islamic banking and finance in the Department of Banking and Finance, UMT. She did her master’s in economics from Islamia University Bahawalpur and UMT. Muhammad Dahiru Shuni  completed his education in Sokoto state and his PhD from the Department of Islamic Studies Umanu Danfodiyo xxi

contributors

University, Sokoto-Nigeria in 2001. Since then, he has been working as an academician teaching and contributing to research in the area of Islamic finance, Shari’ah, politics, and administrative sciences. Teh Suhaila Tajuddin is a member of the Malaysian Institute of Accountants since 2014. She is a graduate at the Universiti Putra Malaysia while her master’s degree is in accountancy, Universiti Teknologi MARA (UiTM), Malaysia. She started her career with Chew & Co., Malaysia followed by securing academia position at the International Islamic University College Selangor, Malaysia. Her research interests are in business taxation and business zakat. Her research is presented in International conferences in Thailand, Egypt, and Pakistan. Imam Uddin holds a PhD in Islamic Business & Finance from University of Karachi with emphasis on rules and regulations of Islamic Banking & Finance His areas of expertise include Islamic Banking & Finance, Islamic Economics, Islamic Jurisprudence, Fiscal Laws & Humanities. He presented his work at various conferences and published widely in local and International journals. He served the Islamic Banking Group (AIBG) of the National Bank of Pakistan (NBP) as Vice President in the Compliance group & Product Development Wing. Rodney Wilson is reckoned as the founder of the Islamic finance programme at Durham University in the United Kingdom where he continues as an Emeritus Professor. He was a Visiting Professor at the Qatar Faculty of Islamic Studies in 2009, 2010 and 2012 and from 2013 to 2017 he has been an Emeritus Professor at the International Centre of Education in Islamic Finance (INCEIF), Kuala Lumpur. Professor Wilson was awarded the Islamic Development Bank prize in Islamic banking in 2014 in recognition of his academic work on the subject. Professor Wilson has written a dozen of books and over 40 articles. His recent works are: (i) Legal, Regulatory and Governance Issues in Islamic Finance, Edinburgh and Columbia University Presses, 2012. (ii) Economic Development in the Middle East, Routledge, London and New York, first edition, 1995, second edition, 2013. (iii) Islam and Economic Policy, Edinburgh University Press, 2015.

xxii

FOREWORD

Significant progress in poverty alleviation, social empowerment, and financial inclusion has been made in the past few decades. However, as populations increase in a world that continues to face global crises both natural and man-made, the number of people subject to widespread poverty and lack of quality education, health care, quality shelter, and employment remains considerable. The latest calamity, the COVID-19 pandemic, highlights human vulnerability despite the technological advancement made by mankind in the past century. Against this landscape, can Islamic finance become truly responsible, inclusive, and ethical, while contributing to the planet’s growth and development? This book, with the recurring message of sustainability and inclusivity presented in quantitative proposals and evident-proving case studies, seeks to present the case for it. While Islamic economy and finance have made an impact in trade and banking, their rich inherent social justice potentials are underutilised, particularly as a meaningful resource for poverty alleviation. In reviewing the existing regulatory and institutional frameworks of Islamic banking and finance (IBF) as well products available in the market, the researchers briefly analysed topics ranging from a feasible dual-banking system to Islamic marketing values, IBF human capital development, and success stories of zakat and waqf. There are also lessons in the IBF journey in jurisdictions around the world including the slow uptake of UK’s Islamic banks. Where relevant, proposals of institutional, infrastructural, and behavioural improvements are offered by the researchers to optimise IBF’s real potential, vis-à-vis socio-economic justice, including advocating for a musawwamah card vs a credit card. Another area given its due recognition is the halal economy, which saw a total spending of US$2.02 trillion in 2019 on halal food, pharmaceuticals, cosmetics, modest fashion, travel, and halal media according to the State of the Global Islamic Economy Report 2020/2021. Transcending

xxiii

F oreword

religiosity-based users, the halal brand is also attracting Green consumers for being ethically sourced through fair business practices. In this unusual time in the history of humanity, we are reminded yet again of our interwoven shared future. As the world rationalises, resets, and recovers, this is an opportune time for a financial, economic, and social system that is people- and environment-centred to showcase its capabilities and possibilities to all who want a sustainable future. IBF’s concept of promoting real economy, equitable partnership, and financial inclusion resonates with the main agenda of governments around the globe for a fairer and healthier planet. This is the time to actively pursue sustainable investments and social finance in consonance with the global resurgence towards a more equitable socio-economic existence, which is the core principle of Islamic social finance. This book is aimed at a wide readership, for both proponents of Islamic finance and those curious about the four-century-old systems that are being offered as a potential 21st-century solution. From the chapters, students and lecturers may find possible research topics; regulators and policy makers, legal and technical improvement ideas; and knowledge seekers, an overview of different topics relating to the foundations of IBF. Lastly, we hope that this book may shed more light on the holistic approach in mitigating the global inequality gap and the shared desire for human excellence rather than just human survival. Prof. Dr. Azmi Omar President & CEO, INCEIF Kuala Lumpur, Malaysia

xxiv

1 CONTEMPORARY ISSUES IN ISLAMIC SOCIAL FINANCE Hussain M. Qadri and M. Ishaq Bhatti

1.1 Preamble Recent studies and data evidence from PEW Research1 Centre confirm that almost all Muslims in the world either living in Muslim majority and/ or non-Muslim minority countries are facing serious socio-economic and ethno-religious problems. Some of these problems include ethnic cleansing of Muslims (e.g., Myanmar , India, China, Kosovo, Indian-Kashmir, and Palestine), spread of poverty in Muslim countries, outstanding external debt and extensive unethical behaviour, unemployment, drug abuse, and higher crime rates among Muslim communities in non-Muslim majority countries (e.g., countries in Australia, China, Europe, India, and the USA where Muslims are in minority). Some contemporary scholars relate these problems with wars imposed on Muslim countries (Afghanistan, Iraq, Iran, Libya, Palestine, Syria and Yemen ) and also the economic embargoes and the crippling policies of former colonial administrations, whereas others point to the governmental incompetence and corruption that result in socio- economic injustice to Muslims (see Mohsin 2020). Some of the aforementioned factors may have catalysed a worsening of the socio-economic condition of Muslims in many countries. This may be due to corrupt politicians and ignorant policy makers with regard to Islamic socio-financial institutions, including zakah (alms), khairat (charity), sadqat (donations), waqf (Islamic endowment), takaful (insurance), and sukuk (social or green bonds). These institutions were conceived to spread ethical behaviour, eliminate riba (usury/interest), empower the poor and needy, encourage financial inclusion, and eliminate poverty. This edited volume comprises the best papers presented at the third World Islamic Economics and Finance Conference (WIEFC) that was held during 25–26 January 2020. The theme of the third WIEFC was, ‘People Empowerment, Social Innovation and Role of Islamic Economics and Finance’. The conference was organized by the Minhaj University Lahore (MUL) in collaboration with La Trobe University, Melbourne, Australia along with knowledge partners, the Islamic Development Bank’s Jeddah-based DOI: 10.4324/9781003050209-1

1

H ussain M . Q adri and M . I shaq B hatti

Research Institute (IRTI), Cambridge Institute of Islamic Finance, United Kingdom, the State Bank of Pakistan, AAOIFI Bahrain, and the College of Banking and Financial Studies, Oman. In the subsequent sections of this chapter, we will discuss in brief the topics of interest covered in this book. Section 1.3 presents a summary of the chapters. The final section contains some concluding remarks.

1.2 Brief description This edited volume contains 23 chapters including this introductory chapter. The book is based on selected articles; each chapter is reviewed by a reviewer and an editor. This volume begins with a preface by the eminent Professor Azmi Omar, Vice Chancellor and President of INCEIF University, Malaysia. The book covers the following important topics related to Islamic social finance; -

Capital structure of Islamic banking and finance (IBF) products under inclusion (taqlid al-madahib) IBF well-being tawhidi index Risk-management issues in IBF Performance measures of IBF Behavioural and social aspects of IBF Zakat, waqf, and other charity institutions in IBF Inclusive and sustainable growth in the IBF industry Islamic marketing and customer care Auditing and reporting of social aspects of IBF Credit and musawamah cards in IBF Halal industry and the role of IBF Islamic insurance – Islamic bonds (sukuk)

1.3 Chapter-wise structure and summary This chapter presents an introductory note in the area of contemporary issues in Islamic social finance. Chapter 2 is authored by Johaina Khalid and Dawood Ashraf (Islamic Development Bank, Saudi Arabia) on the issue of capital structure in IBF by analysing its profit-sharing aspects. They argue that Islamic banks are different from conventional banks, both in terms of their assets and liabilities due to profit-sharing investment (PSI) accounts, a quasi-equity, and a buffer to bear the financial risk structure. It compares the impact of deposits on market value, earnings per share (EPS), and financial risk of shareholders. It observes significant positive relationship between PSI accounts and EPS. Contrary to the general belief, we find evidence that higher growth in PSI accounts leads to elevated financial risk. The higher financial risk can be attributed to the income-smoothing practices of Islamic 2

C O N T E M P O R A RY I S S U E S I N I S F

banks as they announce the profit rates of PSI accounts like the deposit rates offered by their conventional counterparts. Chapter 3 deals with the development of a spiritual index model to measure human prosperity under the objectives of shari’ah by an established Canadian scholar Masudul Alam Choudhury. This chapter proposes a unified model for the standardization and harmonization of the universal law of primal ontology originated by the Qur’anic universal education of peace, spirituality, and prosperity. The chapter concludes by proposing a general method of computing indices that can be adopted by the global development agenda to meet millennium and sustainability goals. The next three chapters are associated with the study of risk management and risk sharing in IBF. Rodney Wilson in Chapter 4 presents a case of risk management and risk sharing in IBF. He argues that community-based social solidarity is far better than individualistic gain at the expense of others. Risk cannot be avoided as it is inherent in economic and commercial relations and business cycles, as identified by Ibn Khaldun. Wilson further points out that businesses cannot isolate themselves from these macroeconomic developments, and risk sharing can help in mitigating some of the negative effects. Chapter 5 concentrates on debt, risk and Islamic moral economy, authored by Toseef Azid, Osamah Al Rawashdeh (Saudi Arabia) jointly with Muhammad Omer Chaudhry. They used the quantitative method to study the nexus between lenders’ rights and borrowers’ duties. They claim that Islamic moral policy to lend resources as a financial support to socially deprived community members is a duty of the rich on zero-interest money. They proposed an Islamic financial institution that is patronized by the state to train society on shari’ah’s different dimensions of debt and how to help the poor to ensure real socio-economic growth. In Chapter 6, Atiq ur Rehman outlines the role of the State Bank of Pakistan’s policy rate in an economy that is operational on both Islamic and conventional finance. The markup in IBF debts is associated with the bank’s policy rate. The higher the policy rate, the higher would be the ‘markup payments’ on domestic debt. Due to the increase in policy rate during the tenure of the present government, the markup payments in IBF on the domestic market formulated to 35% of the federal budget, making it the single-largest head of expenditure in the budget. The higher policy rate by central banks causes an increase in inflation owing to the cost and markup payment channels. This chapter discusses how the policy of adapting a better policy rate has contributed to the economic suffering of Pakistan using the so-called markup rate in IBF. Chapter 7 is authored by the editor Hussain Mohi-ud-Din Qadri on the topic of religion, culture, and Islamic marketing. It attempts to build a bridge between religiosity-based marketing values for IBF clients to make purchasing decisions on the choice of day-to-day consumer products. This chapter 3

H ussain M . Q adri and M . I shaq B hatti

overarches the discussion on the link between religion and culture and Islamic marketing values. In Chapter 8, Anwar Shah (Pakistan) developed the theoretical model for job creation at the micro level and highlighted the role of the IBS in enhancing the living standards of the clients and local communities. In the model, IBS allows payment over and above the available fund on behalf of household (overdrafting), which the household can remit to the bank on a monthly basis later. The incentive of banks is the commission to be deducted from the company’s bill. It is a win-win transaction for both clients and the participating banks. The proposed model is likely to create demand for home services such as plumbing, electricity, glass fitting, etc., leading to the creation of jobs for skilled people and their absorption into the market. The title of Chapter 9 is ‘Lessons from the UK’s dedicated Islamic banks’, authored by Mohammed Amin. This chapter analyses the practical aspects of IBF in the United Kingdom. The author reviewed six Islamic banks’ performance and activities that can provide extensive lessons to Islamic banks in Western countries. In this study, a qualitative research methodology is used to reveal that poor planning caused losses because the bank was unable to take on the risk of providing home purchase plans until after it was taken over and received a significant capital injection. Some of the other Islamic banks also look sub-scale and therefore appear virtually condemned to steadily lose money. These banks’ operations and poor execution of fund in comparison with conventional banks incurred heavy losses. The chapter proposes careful management, execution, and precaution to improve the running of financial institutions. Chapter 10 is contributed by Salman Ahmed Sheikh who discusses how Islamic finance promotes sustainable economic growth through its principles, values, institutions, and instruments. It presents a theoretical analysis under equilibrium to demonstrate optimal funds allocation to Islamic capital market portfolios. The proposed circular model is likely to result in boosting the aggregate demand components of consumption and investment, and it outlines the intervention strategy used by various Islamic instruments and institutions for achieving each of the UN’s 17 sustainable development goals (SDGs). The provision of money-based lending in the current banking practice locks a huge amount of liquidity in the money market instruments and fails to achieve the needed SDGs. In Chapter 11, Syed M. A. R. Shah, Muhammad Umar Farooq, and Muhammad Akmal contribute on the topic of ‘embracing Islamic banking as a new engine towards the growth of dual banking system in Pakistan’s economy’. It uses data from 13 Islamic banks, between 2005 and 2017, for the analyses on bank-specific and macroeconomic variables using econometrics methods and observed a causal relationship between the selected IBF variables and economic growth, which is consistent with the supply-leading view of Schumpeter. The chapter concludes with favourable recommendations to 4

C O N T E M P O R A RY I S S U E S I N I S F

policy makers for providing a comfortable environment and institutional support to increase the share of IBF to achieve the objective of sustainable inclusive economic growth, especially in countries with Muslim majority: Malaysia, Indonesia, Pakistan, Qatar, UAE, Egypt, Kazakhstan, Turkey, Bahrain, Saudi Arabia, and Kuwait. Chapter 12 is on the role of zakat in poverty reduction. The author of the chapter is Aminu Alhaji Bala from Sokoto, Nigeria. He presents a case of the social aspects of IBF products that can alleviate poverty. The author argues that zakat mechanism has been proven to be successful by a case study of the Zakat and Endowment Commission of Nigeria that helped the local community overcome poverty. In this chapter, the author explains how endemic poverty challenges bedevilling the Muslim residents of Sokoto state and it has been resolved by utilizing the Islamic social security system (the zakat model). In Chapter 13, authors Mohammad Ayaz, Khurram Faisal Jamal, and Sadaf Shaheen address an important issue of handling the Charity Fund Account (CFA), created from non-shari’ah banking activities, like minor interest earnings (less than 5% of the total profit) and late-instalment penalties and fines to IBF clients. The authors investigated a case of M-Bank from Pakistan on the function of a CFA account in which all non-shari’ah M-Bank’s earnings are maintained for six years between 2014 and 2019. The pattern of the distribution of this account for charity was studied under shari’ah compliancy. It is observed from M-Bank’s financial statements that though the bank maintained full disclosure record, some inconsistencies of fund flow to charities were noted as there were no strict guidelines of its disbursement from the State Bank of Pakistan. The authors suggested regulators should develop uniform disclosure policies of CFA type charity funds for the rest of the IBFs in the country and regions by an international body. In Chapter 14, the idea of the Islamic bank’s musawamah card versus credit card is presented, and some future opportunities, challenges, and solutions are mentioned by three well-known, award-winning young experts: Imam Uddin, Muhammad Shujat Saleem, and Abdur Rahman Aleemi. The authors investigated the development of the musawamah-based (credit) card in line with conventional credit cards. They used the qualitative method to identify the opportunities and challenges in the adoption of a musawamah-based credit card by Islamic banks in general and specific to Pakistan. For this purpose, experts’ interviews have been conducted from shari’ah and business heads of five full-fledged Islamic banks in the country. The authors’ findings are: (i) musawamah-based (credit) cards can be issued to the public, (ii) the service fees associated with these cards will be higher, and (iii) their functionality may be expensive due to shari’ah-compliant operational issues. Some recommendations on overcoming these problems are made, but they will need approval from regulatory bodies. 5

H ussain M . Q adri and M . I shaq B hatti

Chapter 15 is authored by Muhammad Dahiru Shuni from Nigeria on the issue of the socio-economic impact of a waqf product, yet another important product of Islamic finance. This chapter begins with the basics of waqf, and it seeks to examine the concept of waqf in Islam and to investigate its social and economic impacts on the general public as a charitable endowment institution. It discusses various forms of waqf, its purpose and financial component as a part of IBF to alleviate poverty. The author discusses the various activities of waqf by the government commission for waqf formed in Nigeria. Chapter 16 discusses issues of reporting zakat earnings and distribution from businesses based on solid evidences from Islamic financial institutions (IFIs) like IBFs. This chapter is written by Teh Suhaila Tajuddin and Izlawanie Muhammad from Malaysia. The authors review some of the reporting standards including Malaysian Accounting Standards Board, Technical Release i-1: Accounting for Zakat on Business and AAOIFI, Financial Accounting Standard 9: Zakah and Financial Reporting for Islamic Banking Institutions by the Central Bank of Malaysia (BNM). In this chapter, the authors explore business zakat reporting among IFIs in Malaysia. They used qualitative research methodology to compare three public-listed IFIs business zakat reporting. Content analysis on the annual reports of the IFIs was conducted to identify the recognition of zakat, measurement, presentation, and disclosure of zakat on business. The study observes some similarities, differences, and the current state of business zakat reporting of the IFIs. It suggests a business zakat reporting standard ought to provide a comparable and reliable financial information on IFIs. It also promotes transparency and completeness of business zakat assessments for the stakeholders including BNM. Chapter 17 is written by Aini Jaapar, Siti Salwa Salleh, Mazlina Mahdzar, Ahmad Shahril Azwan Abdul Rahim (from Malaysia) on meeting the human resources development and human capital in IBF by proposing a pre-higher education programme (PPT) to uplift the B40 economic position via Islamic social finance. This chapter consists of theoretical and empirical exercises based on the following three steps: (i) acquiring knowledge, (ii) gathering data, and (iii) analysing and validating data. It analyses each of these components that make up the PPT framework that embraced association and integration of internal and external operators, providers, funders and the targeted demographic, the B40 youth. The study concludes that this blueprint proves that the University of Technology Mara-UiTM contributes to one of the main agendas of the government’s efforts in transforming in turn the nation’s development, to achieve human development with regard to IBF. The rest of the few chapters are associated with halal market issues. In Chapter 18, the demand for halal products and services is investigated, considering the International Convention on Halal Industries authored by Ibrahim Danjuma. The study aims to identify some of the challenges faced 6

C O N T E M P O R A RY I S S U E S I N I S F

by halal industries and proffers possible solutions on addressing the identified challenges. This study enumerates that there are strong concerns about halal certification e.g. the role of universal regulatory agency on halal products or industries. This study also reveals that how the lack of awareness about the concept of halal products have significantly thwarted the potential growth of this sector, particularly on exportation. At the end, the author proposes the formulation of some unified and international halal standards through the establishment of the International Halal Convention, following which a move towards a universal standard will pave the way for consumers to know exactly the ingredients of the products they absorb into their bodies and also to increase awareness on halal products. Chapter 19 is authored by Hadia Saqib Hashmi and Hassnain Ali on the topic of ‘Education of Halal Food Audit-certification: Challenges and Future Aspects’. In this chapter, the authors point out that due to an increase in the Muslim population around the world, the demand for halal products will increase multiple-fold. A global unified ‘halal certification model’ is needed to meet the increasing demand. This chapter proposes halal curriculum to educate future generation Muslim youth in forming the human capital in the halal industry. The proposed curriculum includes the difference between halal (permitted) and non-halal (forbidden), halal process, standard setting, certification, auditing, halal label equipment, ingredients, and halal-management issues. It unveils the promotion, growth, development, and sustainability of the global halal industry, and hence justifies halal certification education via the blended mode – face to face in a classroom setting and online using e-learning platforms. Chapter 20 is on ‘Halal tourism optimization to economic growth: An Indonesian case’ authored by Shinta Maharani from Indonesia. In this chapter, the author claims that Indonesia is the largest Muslim country with one of the most popular tourist destinations in the world due to its multicultural texture, ethics, linguistic features, and its location in the Pacific and Indian Oceans, in proximity to the ASEAN countries of Asia and Australasia. This chapter fills the gaps in research by discussing halal tourism within the context of a multitude of amazing landscapes and biodiversity stretching along the equatorial lines and shari’ah-compliant Islamic businesses. It explores the growth of the halal business, halal tourism, and government policy to generate revenue, accelerate economic growth, and enhance the living standard of the citizens. It uses the causality model to study the relationship between business growth and halal tourism, and the impact of social media on halal tourism. This study reveals how halal tourism will enhance the growth rate of Islamic or shari’ah-compliant businesses in the country. The author also highlights how such developments could substantially contribute to the overall economic growth in Indonesia and how such developments would be helpful in increasing government revenues and enhancing the living standard of citizens. 7

H ussain M . Q adri and M . I shaq B hatti

Chapter 21 is on ‘quality services and customers’ loyalty of Islamic banks’ by Shahbaz Sharif, Muhammad Ashfaq, Rab Nawaz Lodhi, and Rashedul Hassan of Pakistan. This chapter studies the emergence of financial technologies and their implications on the banking industry in general. It focuses on the Islamic bank’s customer satisfaction and measures on improving customer loyalty. The authors conduct a survey of Islamic banks’ customers using a convenience-sampling approach. The model consists of six- dimensional variables, like – tangibility, reliability, assurance, sincerity, personalization, and formality. The findings show that most of the customers are satisfied with the services and products provided by their banks and have agreed to repurchase the services and products. The findings of this study suggest that the measurement model of PAKSERV dimensions is appropriate in measuring customer loyalty in Pakistan. The direct effect of service quality on customer satisfaction and loyalty was significant and positive. Moreover, the indirect effect of service quality on loyalty was also significant and positive requiring only partial mediation. The present research is limited to the customers of Islamic banks primarily from the Punjab province, which reduces its generalizability. The findings of this study are useful for decision-makers of Islamic banks to develop drivers of customer satisfaction and loyalty to ensure the continuous growth of Islamic banks. Chapter 22 elaborates on an important and environment-friendly issue of ‘green sukuk’ for financing renewable projects in the area of Islamic social finance by Maryam Saeed. She attempts to find a solution to the energy crises and global warming through green sukuk. A qualitative research method – content analysis – is used to conduct a survey of Pakistani mudarbah and investment companies. The chapter finds that renewable projects, such as solar, wind, and electrical vehicles require a huge investment and government support that cripples attracting funding in this field. That is why mudarbah and investment companies avoid investing in green sukuk. If government plans to make policies with AEDB, energy sectors, vehicle industry, and federal board of revenue in terms of tax relaxations, infrastructure support, and governance, and invests money through green sukuk in renewable projects, then energy crises and global warming challenges can be resolved in Pakistan. The final chapter concludes the book.

1.4 Concluding remarks This book covers various aspects of Islamic social finance that are of interest to financiers, scholars, and students, and this collection can be used as a reference book for policy makers to financially include Muslim citizens. Although social finance is a new area, its roots are more than 14 centuries old. There is a need to innovate in this research area and develop practical tools for banks and financial institutions to have sustainable Islamic social finance systems (see Jouti 2019). One of these areas may be the use of 8

C O N T E M P O R A RY I S S U E S I N I S F

financial technology in all social Islamic finance instruments. For example, developing new tools, like waqf-fintech based on waqf-crowd and waqf-coin (see Setia 2018), NZF2, and Islamic Council of Victoria’s no-interest loan scheme (see Sain et al. 2016) models in Australia3 and Pakistan,4 and it can be extended to the rest of the countries to build a unified model for all Islamic social finance products.

Notes 1 https://www.pewresearch.org/topics/muslims-and-islam/. 2 https://www.nzf.org.au/. 3 htt p s://good she pherd m ic rof i na nc e.org.au /s er v ic e s /no -i nt ere st-loa nscheme-nils/. 4 https://akhuwat.org.pk/.

References Jouti, A. T. (2019). An integrated approach for building sustainable Islamic social finance ecosystems. ISRA International Journal of Islamic Finance, 11(2), 246–266. Mohsin, M. I. A. (2020). A fresh view on Zakah as a socio-financial tool to promote ethics, eliminate Riba and reduce poverty. International Journal of Management and Applied Research, 7(1), 55–71. Sain, M. R. M., Rahman, M. M., & Khanam, R. (2016). Financial exclusion in Australia: can Islamic finance minimise the problem? Australasian Accounting, Business and Finance Journal, 10(3), 89–104. Setia, A. (2018). Reintegrating the legal into the social: reviving Islamic transactional law in the context of the civil economy, with special reference to Waqf. Law and Development Review, 11(1), 209–250.

9

2 IMPLICATIONS OF PROFITSHARING INVESTMENT ACCOUNTS ON THE CAPITAL STRUCTURE OF THE ISLAMIC BANK A comparative study Johaina Khalid and Dawood Ashraf 2.1 Introduction In conventional banks, the capital structure consists of both equity and debt. The major proportion of debt is from deposits made by the public. Depositors do not share risk with equity holders and thus are compensated only for the duration of time the deposits are held with the bank. Whereas in Islamic banks, depositors are like shareholders and share in the profit and loss on investments. Islamic banks perform the same intermediary function of accepting deposits from the general public and investing in the form of financing business activities as conventional banks. However, the difference lies in the risk-sharing nature of depositors of Islamic banks. Islamic principles and jurisprudence (shari’ah) strictly forbid dealing in usury (riba) in any form. Islamic banks are not allowed to accept deposits or lend money based on traditional interest-based transactions, i.e., interest-bearing loans and deposits. Islamic banks usually accept deposits and lend money based on profit and loss sharing. A customer can deposit money with an Islamic bank on the principles of qard-al-hasan or mudarabah. Under qard-al-hasan, depositors lend money to the bank as an interest-free loan with the permission to use these funds. Banks do not share the profit or loss with the account holder. While under mudarabah, more commonly known as profit-sharing investment (PSI) accounts, Islamic banks act as entrepreneurs (mudarib) and provide expertise to the investor (rabb al-mal). Profits are shared between the bank and the PSI account holder according to a pre-agreed ratio in the contract. However, any losses are to be borne by the PSI account holders only to

10

DOI: 10.4324/9781003050209-2

P RO F I T- S H A R I N G I N V E S T M E N T AC C O U N T S

the extent of the amount deposited. Rabb al-mal is responsible only for those losses incurred during the ordinary course of banking business; mudarib is accountable for any other losses incurred due to the misconduct or negligence of the bank. The deposit by rabb al-mal under a mudarabah contract is not treated as a liability of an Islamic bank due to the profit-sharing and loss-bearing nature of the arrangement. In essence, PSI accounts are more like equity than a liability and should not cause a rise in the cost of capital for an Islamic bank. However, this is not reflected in the regulatory capital requirement for Islamic banks. Similar to deposit accounts with conventional banks, regulators consider PSI accounts as a liability and thus require Islamic banks to post the same regulatory capital as any other conventional bank (Ashraf et al., 2016). There is ample research on the capital structure of conventional banks; however, research on the capital structure of Islamic banks is sparse. The study of the capital structure of Islamic banks is vital to all stakeholders. In particular, one of the most important questions that needs to be addressed is whether PSI accounts should be treated as part of the equity or liabilities for their shareholders. Deehani et al. (1999) empirically investigated the capital structure of Islamic banks. They found that shareholders of Islamic banks, without facing any additional financial risk, can enjoy a higher return on their invested capital due to the presence of PSI accounts. Further to the findings of Deehani et  al. (1999), we investigate whether growth in PSI accounts relative to shareholders’ equity impacts income, market value, and shareholders’ return. Also, we test whether growth in income results in any additional financial risk. The empirical model is estimated using quarterly data on a sample of eight banks (five conventional and three Islamic banks) listed on the Karachi Stock Exchange in Pakistan. The sample period is between 2007 and 2012, except for Burj Bank Limited, for which valuation is based on average industry price multiples. The empirical findings suggest that Islamic banks with a higher proportion of PSI accounts show a positive and significant relationship with market value and earnings without any increase in financial risk. Regarding the capital structure, we do not find any significant difference between the capital structure of Islamic and conventional banks. This may be due to the similar capital regulation regime treatment for both Islamic and conventional banks. The findings of this study should be of interest to both banking academics and regulators. Islamic banks offer the potential to withstand financial meltdowns due to their adherence to shari’ah principles of avoidance of riba, investments in real assets and the acceptance of deposits based on profit-sharing and loss-bearing principles. However, there is a need for a different regulatory regime for Islamic banks so that they do not fall into similar practices as their conventional counterparts.

11

J ohaina K halid and D awood A shraf

2.2 Literature review Since Modigliani and Miller’s (1958) seminal work of irrelevance proposition, researchers in corporate finance have debated the determinants of capital structure for nonfinancial firms. As the capital structure for banking firms is treated as constant over cross sections of banks, fewer studies have been conducted compared with nonfinancial firms (Gropp and Heider, 2010). On a global landscape, banking is one of the most regulated sectors in business. Banks are required to hold a specific amount of equity capital on a risk-adjusted basis. Berger and Di Patti (2006) report no significant difference in the capital structure of US commercial banks from nonfinancial firms between 1990 and 1995. They found that banks with a lower equity capital ratio and higher leverage ratio exhibit higher profit levels. Gropp and Heider (2010) further tested the agency problem in the US and European banking sectors between 1991 and 2004 and concurred with the findings of Sakti et al. (2017), among others. Similar evidence is reported in the context of the banking sectors of several other countries. Capital structure studies on conventional banks treat all deposit types as debt, and thus a single measure of leverage is used for empirical analysis. However, deposits in Islamic banks are accepted on a mudarabah basis and, therefore, cannot be considered as debt. As noted earlier, the literature on the capital structure of Islamic banks is sparse. Deehani et  al. (1999) proposed a theoretical model where an increase in PSI accounts relative to equity has a positive impact on market value and the rate of return on equity without any additional financial risk to the bank. They also empirically tested their theoretical model by using a sample of 12 international Islamic banks and concluded that an increase in PSI accounts enables the Islamic bank to increase both its market value and its shareholders’ rates of return without facing any additional financial risk. Pratomo and Ismail (2007) attempted to test the agency cost hypothesis using a sample of 15 Malaysian Islamic banks for the period between 1997 and 2004. They found no difference in the capital structure of Islamic and conventional banks. However, the deposits in Islamic banks were treated as pure debt, similar to the deposits in their conventional counterparts. Research conducted by Shubber and Alzafiri (2008) revealed a positive correlation between market value and the size of deposits of four big Islamic banks from Kuwait, Dubai, Qatar, and Bahrain during the period from 1994 to 1996. Moreover, they found that the weighted average cost of capital (WACC) of an Islamic bank to be independent of its market value. Pellegrina (2009) finds that due to different deposit structures, the effect of capitalization on the cost efficiency of Islamic banks is not as strong as in conventional banks. In contrast, Al-Farisi and Hendrawan (2012) examine the impact of the capital structure on the performance of conventional and Islamic banks found that the capital ratio adversely affects the profit 12

P RO F I T- S H A R I N G I N V E S T M E N T AC C O U N T S

efficiency with the effect being more substantial in Islamic banks compared with conventional banks. It is evident from the above literature review that a higher deposit to equity ratio has a positive impact on the profitability and market values for both Islamic and conventional banks. However, in the case of conventional banks, increasing debt to equity ratios may result in higher financial risk for shareholders. In the case of Islamic banks, an increase in the deposit to equity ratio has no impact on the financial risk due to the profit-sharing and loss-bearing nature of PSI accounts. This study attempts to enhance the understanding of capital structure theory of Islamic banks by specifically addressing the impact of PSI accounts on the performance of Islamic banks and comparing their performance with conventional banks.

2.3 Data sources and methodology This study investigates the impact of PSI accounts on the capital structure of Islamic banks. Also, it provides a comparison with conventional banks in Pakistan by using quarterly data from March 2007 to December 2012. There are five full-fledged Islamic banks in Pakistan: Meezan Bank Limited, Burj Bank Limited, Al Baraka Bank Pakistan Limited, BankIslami Pakistan Limited, and Dubai Islamic Bank Pakistan Limited. Due to the nonavailability of financial and market data for two of the banks for the period under study, we used three Islamic banks for our research: Meezan Bank Limited, BankIslami Pakistan Limited, and Burj Bank Limited. We then compared the performance of Islamic banks with the top five conventional banks operating in Pakistan: National Bank of Pakistan, Muslim Commercial Bank, Habib Bank Limited, United Bank Limited, and Allied Bank Limited. We did not take Islamic windows of the conventional banks due to the nonavailability of separate financial statement data for these windows. Share prices and market data were collected from the Karachi Stock Exchange (KSE) and ZHV Securities (Private) Limited, a corporate member of KSE. Financial data was obtained from published financial statements of individual banks and the State Bank of Pakistan. All the banks in the sample are listed except Burj Bank Limited, for which valuation has been done using price multiple, i.e., average industry price to book ratio to estimate the market value of the firm. Commercial banks in Pakistan accept deposits as current accounts – remunerative, current accounts – nonremunerative, savings deposits, fixed deposits, and financial institutions’ deposits. While Islamic banks accept current deposits as qarde-hasna, savings and investment accounts are accepted on mudarabah basis. In this study, we considered both savings and fixed deposits accounts as PSI accounts. Deehani et al. (1999) proposed that growth in PSI accounts, unlike conventional savings and investment accounts, does not increase any financial 13

J ohaina K halid and D awood A shraf

risk for Islamic banks. Thus, the cost of equity does not increase with the increase in PSI accounts. Moreover, if PSI accounts yield a positive return, then shareholders enjoy additional returns in the form of mudarib’s share of profit. In this study, we will test the following hypotheses separately for Islamic and conventional banks to identify the source of difference in the performance of Islamic and conventional banks. Hypotheses: H1: Growth of deposits relative to equity has a positive impact on the market value of banks H2: Growth of deposits relative to equity has a positive impact on shareholder returns H3: Growth of PSI accounts relative to equity has no impact on the financial risk of banks’ shareholders. 2.3.1 Model specification To isolate the impact of leverage (deposits to book value of equity) on the market value of a bank, we followed the approach adopted by Deehani et al. (1999). We used the following generalized least square – fixed-effect model: MVit = β0 + β1Crit + β2Cnrit + β3Sdit + β4Fxdit + β5Fdit + β6GFCt + εit

(2.1)

where M Vit is the market value of the bank i at the end of quarter t and is the product of the market price of its shares and the number of outstanding shares. Crit is the ratio of current account – remunerative to equity, and Cnrit is the ratio of current account – non-remunerative to equity. S dit is the ratio of savings deposits to equity, and Fxdit represents a ratio of fixed deposits to equity. Fdit represents the ratio of financial institutions’ deposits to equity. To isolate the impact of the global financial crisis, a dichotomous variable GFC t is used that took a value of unity in the last quarter of 2008 and zero otherwise. We estimated the above model twice: one for Islamic banks and one for conventional banks. Two separate models are estimated for shareholder returns and financial risk as an endogenous variable in equation (2.1) for conventional and Islamic banks. Earnings per share (EPSit) is used as a proxy for shareholders’ return. The cost of equity (RE1it) is used as a proxy for the financial risk calculated using the standard Capital Asset Pricing Model (CAPM) developed by Sharpe (1964), that is; E(Rit) = Rft + βt(E(Rmt) − Rft)

(2.2)

14

P RO F I T- S H A R I N G I N V E S T M E N T AC C O U N T S

where E(Rit) is the expected return of bank i’s equity at time t, Rft is the risk-free rate of return, E(Rmt) is the expected return of the market, and βt is a measure of systematic risk and is equal to Cov(Rit, Rmt)/Var(Rmt). Return on equity (RE1it) is calculated by using the average yield offered on a three-month Treasury bill by the State Bank of Pakistan in each quarter as a proxy of risk-free rate. An annualized quarterly return on the KSE 100 index is used as a proxy for market return.

2.4 Descriptive statistics Table 2.1 provides descriptive statistics for the variables used in the study. Panel A of Table 2.1 reports the descriptive statistics for conventional banks, while Panel B shows the descriptive statistics for Islamic banks in our sample. The last column of Table 2.1 reports the t-statistic results for the null hypothesis of equality in the means of conventional and Islamic banks by using an unequal variance approach. The null hypothesis of equality of mean is rejected for all variables at the 5% significance level except for the cost of equity capital, suggesting that investors penalize Islamic and conventional banks equally in terms of their riskiness relative to the market. Among other variables, it is evident that conventional banks are much more prominent in size compared with their Islamic counterparts. The average conventional bank is approximately 11 times bigger than the average Islamic bank in terms of total assets, total deposits, and equity capital. Regarding profitability, conventional banks, on average, have EPS about 18 times higher than Islamic banks. Table 2.2 reports the components of the capital structure in notional and as a percentage of total capital for conventional and Islamic banks in Panel A and Panel B, respectively. Despite the difference in the nature and working of banks, the capital structure for both Islamic and conventional banks looks similar. This similarity can be attributed to the minimum capital requirement set by the regulators under Basel II.1 In terms of deposit structure, Islamic banks, on average, have 24% of their deposit in the current account – non-remunerative, 35% in savings and 39% in fixed-term deposits as compared with 31%, 38%, and 26%, respectively, for conventional banks. This suggests that Islamic customers have a more long-term perspective than customers of conventional banks and is in line with the findings of Ashraf et al. (2016), who found that investors in Islamic mutual funds take a long-term view of their investment due to their religious beliefs. Extending the research of Shubber and Alzafiri (2008), we perform correlation analysis to see the correlation between the market value and total deposits for conventional and Islamic banks. Panels A and B of Table 2.3 report the correlation matrix between the market value and total deposits of conventional and Islamic banks, respectively. Panel A results show no

15

J ohaina K halid and D awood A shraf

Table 2.1 Descriptive Statistics for Conventional and Islamic Banks Variables

Total deposits (TD) Total assets (TA) Equity (EQ) Earnings per share (EPS) Return on equity (ROE) Cost of equity (RE1) Market value (MV) Net income (NI) Current depremun (CR) Current depnon remun (CNR) Savings deposits (SD) Fixed deposits (FXD) Other deposits (OD) Total customer deposits (CD) Financial instdep-rem (FR) Financial instdep-non remun Total financial deposits (FD)

Panel A: Conventional Banks

Panel B: Islamic Banks

obs Mean

obs Mean

Standard Deviation

118 510.708 206.103

69

48.331

51.945

18.28006***

115 670.939 238.410

69

59.332

59.802

20.89758***

115 115

71.059 3.511

31.914 1.649

69 69

6.234 0.197

3.072 0.392

16.80748*** 16.40309***

115

0.051

0.019

69

0.013

0.030

10.67217***

118

0.386

1.953

72

0.153

0.684

120 108.984

61.802

71

7.593

5.982

13.77101*** 17.50923***

Standard Deviation

t-Statistics for Equality in Means

0.98000

115

3.404

1.516

68

0.146

0.298

116

24.886

30.400

70

0.011

0.041

115 135.844

42.970

69

11.791

14.434

23.18731***

115 194.961

85.773

69

16.751

19.618

16.97677***

114 135.320

61.578

69

18.688 18.043

15.32523***

3.541

69

0.221

0.255

115 501.527 171.556

69

47.462

51.977

113

12.866

19.937

69

0.839

0.813

5.003004***

116

9.749

17.700

67

0.030

0.054

4.48913***

115

22.512

36.477

70

0.857

0.815

4.960930***

120

2.051

6.838502***

4.281309*** 21.38378***

This table reports descriptive statistics for a sample of eight (five conventional and three Islamic) banks. The data is presented in billions of Pakistani rupees except for EPS, RE1, and ROE. Equality of mean test is performed to analyze the difference in means with t-statistics based on unequal variance. The data are pooled over the period from 2007:Q1 to 2012:Q4. Asterisks show statistical significance at the *10%, **5%, and ***1% levels.

16

P RO F I T- S H A R I N G I N V E S T M E N T AC C O U N T S

Table 2.2 Capital Structure of Islamic and Conventional Banks Customer Deposits CR

CNR

Financial Institutions’ Deposits

SD

FXD

OD

FR

FNR

Total Capital

EQ

Panel A: Conventional Banks Average 24.886 135.844 194.961 135.320 2.051 12.866 9.749 71.059 586.735 values As a %age 4.24% 23.15% 33.23% 23.06% 0.35% 2.19% 1.66% 12.11% of capital Panel B: Islamic Banks Average 0.011 values As a %age 0.02% of capital

11.791

16.751

18.688

0.221

21.61%

30.70%

34.25%

0.40% 1.54%

0.839

0.030

6.234 54.565

0.06% 11.43%

This table reports components of capital structure in terms of deposits and equity in notional as well as a percentage of total capital (TK). Where TK= customer deposits (CD) + financial institutions deposits (FD) + the book value of shareholders’ capital (EQ). CD includes current accounts remunerative (CR), current accounts non remunerative (CNR), savings deposits (SD), fixed deposits (FD) and other deposits. FD includes financial institution deposits-remunerative and financial institution deposits-non remunerative. All figures are reported in billions of Pakistani rupees unless otherwise stated.

Table 2.3 Correlation Matrix between Market Value and Total Deposits Panel A: Conventional Banks

Panel B: Islamic Banks

Correlation

Market Value

Total Deposits

Correlation

Market Value

Total Deposits

Market value Total deposits

1 0.059247 (0.52390)

1

Market value Total deposits

1 0.809132 (0.00000)

1

This table reports the correlation between the market value and total deposits of conventional and Islamic banks. Data is pooled over parenthesis indicate probability.

significant correlation between market value and total deposits in conventional banks. However, in the case of Islamic banks, there is a strong positive correlation between the two variables, as reported in Panel B. The correlation results support hypothesis 1 for Islamic banks, indicating that PSI accounts accepted based on mudarabah have a positive impact on their respective market value. The positive effects of PSI accounts are in line with the findings of Deehani et al. (1999) and Shubber and Alzafiri (2008). 17

J ohaina K halid and D awood A shraf

2.5 Empirical estimations Based on the descriptive statistics, Islamic and conventional banks show a considerable heterogeneity between values of parameters; we perform a separate estimation for each type of bank. Within the sample, heterogeneity has been controlled using the fixed-effects model. As indicated by the literature, the use of the fixed-effects model for panel data is a well- established approach. Table 2.4 reports the estimation results for three different dependent variables: market value (MVit), shareholders’ return (EPSit), and return on equity (RE1it) based on the model developed in equation (2.1) under Panels A, B, and C, respectively. 2.5.1 Impact of deposits on market value Table 2.4 reports the estimation results for the impact of deposits on the market value of conventional banks. The coefficient of current accounts remunerative (Crit) is positive and significant. In contrast, the coefficients of current accounts non-remunerative (Cnrit) and savings deposits relative to equity (Sdit) on the market value of conventional banks are negative and significant. Current accounts – non-remunerative can be drawn without any notice, and the market may view it as a negative factor. On the other hand, savings deposits are expected to be negative for conventional banks since these deposits accrue expenses and thus reduce the market value of banking firms. In the case of Islamic banks, the coefficient of savings deposits is not significant; however, the results suggest that the market views savings accounts as loss-sharing instruments and thus consider it as a contributing factor to the market value. There is no other notable difference between the conventional and Islamic banks’ coefficients, as reported in column 3 of Table 2.4. The results for conventional banks are consistent with the theory put forward in this chapter that deposits representing debt increase the costs of the firm and thus decrease the market value. On the other hand, the negative impact of CNR on Islamic banks can be attributed to the fact that CNR is accepted as qard e hassna in Islamic banks (in Pakistan). Thus, CNR is represented as a debt of the firm and can have the same impact as that of increasing debt in a firm. 2.5.2 Impact of deposits on earnings per share The possible impact of deposit growth on the earnings per share for a conventional bank is unclear. It may be negative due to the costs associated with interest payments. On the other hand, growth in deposits may lead to more lending, thus more interest income for a conventional bank and a positive impact on the earnings per share. For an Islamic bank, however, the effect 18

19

1340.0012*** (136.30379) 406.72208*** (107.63051) −171.71317*** (50.60228) −105.76327*** (35.34937) 65.27972 (49.29408) 30.83289 (129.08976) −176.20920** (70.44721) 0.9286 89.980*** 96

39.27366** 7.633119*** (15.61384) (0.72012) −19993798 0.378845 (802.60243) (0.69719) −19.92857** −0.393705 (9.44841) (0.36379) 10.09227 −0.499830** (9.62046) (0.20205) −0.5610872 −0.701538*** (5.91137) (0.22159) 2.368587 −2.260086** (13.81786) (0.99043) −1500146** – (7.12425) – 0.865 0.857 31.557*** 58.31** 66 108

Conventional

Conventional

Islamic

Panel B: EPSit

Panel A: MVit

0.157844 (0.11217) −3.32468 (3.65634) −0.390752*** (0.08119) −0.066226 (0.04580) 0.274331*** (0.05000) 0.406143*** (0.16128) – – 0.853 39.246*** 63

Islamic 0.534437 (0.84324) −0.85624 (0.71970) −0.122742 (0.20379) −0.011046 (0.10875) 0.306483 (0.20769) −0.045996 (0.60116) −1.454684*** (0.17378) 0.1149 1.311 112

Conventional

Panel C: RE1it

−0.303143 (0.41800) −4.341805 (12.51032) −0.016481 (0.40764) 0.591828** (0.29700) −0.283408 (0.21368) 0.651321 (0.61495) 2.247487*** (0.22637) 0.511 6.502*** 66

Islamic

This table reports the estimation results for three different dependent variables: market value (MVit), shareholders’ return (EPSit), and return on equity (RE1it) based on the model developed in equation (1) under Panels A, B, and C, respectively, using the fixed effect model. Standard errors are reported in parentheses. Statistically significant at the *10%, **5%, and ***1% levels.

R-squared F-value Observation

GFCt

Fdit

Fxdit

Sdit

Cnrit

Crit

Constant

Dependent Variable

Table 2.4 Estimation Results on the Impact of Deposits on the Market Value, Earning per Share and Cost of Equity of Islamic Banks

P RO F I T- S H A R I N G I N V E S T M E N T AC C O U N T S

J ohaina K halid and D awood A shraf

of PSI accounts should be positive due to its profit-sharing and loss-bearing nature. For current accounts, the impact may be detrimental since this is treated as a loan – qard e hassna and the depositor can demand it at any time. According to the capital structure theory for Islamic banks, if PSI accounts are accepted based on mudarabah and yield positive income, then an increase in shareholder returns occurs without incurring any additional financial risk. We estimated the model, as stated in equation (2.1) for EPSit, is dependent on all the same independent variables. The estimation results are reported in Table 2.4, Panel C for conventional and Islamic banks. The estimation results are in line with our expectations. The coefficients of interest-bearing accounts for savings and fixed deposits are negative and significant, suggesting that these accounts negatively affect the earnings per share of conventional banks. Whereas in the case of Islamic banks, fixedterm PSI deposits are positive and significant, suggesting the profit-sharing and loss-bearing nature of these accounts. The coefficient of current – non-remunerative deposits for Islamic banks is negative and significant, representing its nature as a debt. These empirical results support Hypothesis 2 for Islamic banks, consistent with the research findings of Deehani et al. (1999) and Shubber and Alzafiri (2008). 2.5.3 Impact of deposits on the cost of equity In this study, we used the cost of equity (RE1it) as a measure of the financial risk to shareholders calculated by using equation (2.2). The growth of savings and fixed deposits in Islamic banks do not result in an increased risk to shareholders because depositors of Islamic banks are not guaranteed any fixed return or even return of principal. However, this is not the case with conventional banks, who are liable to pay interest and principal on time, thus resulting in a financial burden to the shareholders of a conventional bank. Panel C of Table 2.4 reports the impact of these deposits on the cost of equity for the selected sample of banks. The empirical results show no significant relationship between the cost of equity and deposits. However, in the case of Islamic banks, short-term PSI accounts show a positive and significant relationship with the cost of equity. This significant positive impact of short-term deposits on the cost of equity may highlight the issue of displaced commercial risk that most of the Islamic banks are engaged in attracting new deposits.2 Although the independence of the WACC is assumed, Deehani et al. (1999) and Shubber and Alzafiri (2008) all ignored the practical aspects when conducting their research. A positive and significant coefficient of short-term PSI accounts on the cost of equity indicates the increase in the displaced commercial risk of shareholders, thus requiring a higher return on their funds.

20

P RO F I T- S H A R I N G I N V E S T M E N T AC C O U N T S

2.6 Conclusions Islamic banks offer their customers interest-free banking services. The depositors of Islamic banks can deposit either as an interest-free loan (qard e hasana) or as a PSI account under a mudarabah contract wherein the depositor shares the profit with the bank and bear losses, if any are incurred in the value of the bank’s portfolio. PSI accounts, due to their profit-sharing and loss-bearing nature, are treated as equity rather than debt as in the case of conventional banks. Due to this difference in the nature of accounts, managers of Islamic banks can decide an optimal capital structure where PSI accounts can be treated as equity providers, resulting in a positive impact on market value and earnings per share at no additional financial risk to shareholders. This study has empirically verified the differences in the capital structure of Islamic and conventional banks in Pakistan by adopting Deehani et al. (1999) methodology. Although Islamic banks have witnessed rapid growth in the past few years, they have not reached the level of conventional banks, and this requires caution in the estimation and interpretation of empirical results. The empirical results suggest that the capital structures of Islamic and conventional banks are very similar concerning the proportion of deposits to equity mainly due to the adherence to the same regulatory capital standards. This strict capital regulation results in Islamic banks holding more equity than is required, if the different nature of their accounts is taken into consideration and thus holding them to a similar capital structure as that of a conventional bank. Our findings are mostly consistent with the capital structure theory of Islamic banks by Deehani et al. (1999) except for a positive and significant relationship of cost of equity with short-term PSI accounts. This specific finding highlights the issue of displacement of commercial risks where Islamic banks compensate PSI account holders at the cost of their shareholders. The income smoothing practice of Islamic banks, pegging the rate of returns to conventional banks’ deposit rates and distributing a similar profit rate even though a loss in their portfolio of assets are some of the examples that may cause the relationship to reverse. The limitations of this study include the small sample size for Islamic banks, non-availability of data and the use of industry averages and proxies for the valuation of unlisted Islamic banks. The study used the CAPM for determining the required rate of return on equity in both Islamic and conventional banks; however, the use of the CAPM in its pure form for Islamic banks is not well established. There exists no financial index in Pakistan, which can be used as a benchmark, the KSE 100 index, which includes both financial and nonfinancial firms, has been used to determine market returns. Although this study compares the outcomes of Islamic banks with their conventional counterparts, all big conventional banks in Pakistan in

21

J O H A I N A K H A L I D A N D D AW O O D A S H R A F

terms of deposits have Islamic windows. Thus, the sole impact of deposits from conventional banking on the market value could not be separated. The future research areas may include exploring the determinants of capital structure in Islamic banks and investigating the role of ownership structure, deposit insurance, and capital adequacy regulations on the capital structure of banks. Coming up with ways to deal with profit-sharing investment accounts in determining the capital adequacy requirements of Islamic banks also holds great importance for the banks as well as regulators. Furthermore, finding out the ways to measure the required rate of return by profit-sharing investment account holders in Islamic banks and comparing it with the necessary rate of return on equity in Islamic banks is also essential to find out the perceived risk by each type of capital provider in Islamic banks and their possible reasons. Interested researchers may also benefit from Alam and Seifzadeh (2020) for other possible areas of future research in this domain.

Glossary of Arabic terms Mudarabah contract is a trustee financing contract, where one party, the financier, entrusts funds to the other party, the entrepreneur, for undertaking an activity. Mudarib means an entrepreneur or a manager of a mudarabah project. Rabb al-mal refers to the owner of capital or financier in a mudarabah partnership agreement (also sahib al-mal). Riba is literally ‘excess’ or ‘increase’, and covers both interest and usury. Shari’ah is Islamic religious law derived from the Holy Qur’an and the sunna.

Notes 1 In Pakistan, both conventional and Islamic banks are subject to the same minimum capital adequacy requirements. Ashraf et al. (2016) report similar trend for the global sample of banks. 2 Islamic banks are engaged in income smoothing practices so as to offer a competitive return on their depositors and thus to avoid withdrawal risk. In this practice, the bank (mudarib) often forgoes its own share of profit to offer a rate of return which is competitive to the rate offered by their conventional counterparts. The practice of compromising the shareholders’ return exposes the bank and its shareholders to a unique type of risk called displaced commercial risk (Sundararajan, 2008; Toumi et al. 2019).

22

P RO F I T- S H A R I N G I N V E S T M E N T AC C O U N T S

References Alam, I., & Seifzadeh, P. (2020). Marketing Islamic Financial Services: A Review, Critique, and Agenda for Future Research. Journal of Risk and Financial Management, 13(1), 12. Al-Farisi, A. S., & Hendrawan, R. (2012). Effect of Capital Structure on Banks Performance: A Profit Efficiency Approach Islamic and Conventional Banks Case in Indonesia. International Research Journal of Finance and Economics, 86, 6–19. Ashraf, D., Rizwan, M. S., & L’Huillier, B. (2016). A Net Stable Funding Ratio for Islamic Banks and Its Impact on Financial Stability: An International Investigation. Journal of Financial Stability, 25, 47–57. Berger, A. N., & Di Patti, E. B. (2006). Capital structure and firm performance: A new approach to testing agency theory and an application to the banking ­industry. Journal of Banking & Finance, 30(4), 1065–1102. Deehani, T. A., Abdul Karim, R. A., & Murinde, V. (1999). The Capital Structure of Islamic Banks under the Contractual Obligation of Profit sharing. International Journal of Theoretical and Applied Finance, 2(3), 243–283. Gropp, R., & Heider, F. (2010). The Determinants of Bank Capital Structure. Review of Finance, 14(4), 587–622. Modigliani, F., & Miller, M. H. (1958). The Cost of Capital, Corporation Finance and the Theory of Investment. The American Economic Review, 48(3), 261–297. Pellegrina, L. D. (2009). Capital Structure, Effeciency and Governance: A Comparison between Islamic and Western Banks. Moral Values and Financial Markets: Assessing the Resilience of Islamic Finance against Financial Crisis. Pratomo, W. A., & Ismail, A. G. (2007, November 29). Islamic Bank Performance and Capital Structure. MPRA Paper, No. 6012. Sakti, M. R. P., Tareq, M. A., Saiti, B., & Akhtar, T. (2017). Capital Structure of Islamic Banks: A Critical Review of Theoretical and Empirical Research. Qualitative Research in Financial Markets, 9(3), 292–308. Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. The Journal of Finance, 19(3), 425–442. Shubber, K., & Alzafiri, E. (2008). Cost of Capital of Islamic Banking Institutions: An Empirical Study of a Special Case. International Journal of Islamic and Middle Eastern Finance and Management, 1(1), 10–19. Sundararajan, V. (2008) Issues in Managing Profit Equalization Reserves and Investment Risk Reserves in Islamic Banks. Journal of Islamic Economics, Banking and Finance, 4, 1–11. Toumi, K., Viviani, J. L., & Chayeh, Z. (2019). Measurement of the displaced commercial risk in Islamic Banks. The Quarterly Review of Economics and Finance, 74, 18–31. Ullah, I. (2015). Islamic Bonds (Sukuk) in Malaysia. Islam and Civilisational Renewal, 6(4), 489-–508.

23

3 TAWHID INDEX OF GLOBAL WELL-BEING AS THE PRINCIPAL INDICATOR OF SPIRITUALITY AND DEVELOPMENT Masudul Alam Choudhury 3.1 Introduction The understanding of the foundational ontological law in Islam, namely the monotheistic oneness of God termed Tawhid, as the one that meets the universal well-being in the global sense, and not confined to Muslims alone, has been grossly ignored by shari’ah scholars and the realm of shari’ah construed as the way to Islamic law. In most research on the shari’ah, the three elements of its inner configuration, namely, the Qur’an, Prophetic practices called sunnah, and human juristic interpretations and practices known as fiqh, have been intertwined in an incoherent way. The fiqh interpretation as a juristic approach has historically served the interests of sects and mostly financial and legal groups among Muslims. Thus, the exegesis of Qur’anic law also wisely directed by the sunnah, which is the carrier of the Qur’anic law to the generic and specific cases of the issues and problems under study, has been marred by human wishful interpretations. Examples of such cases are found in the contrariness of interpretations in the shari’ah among different Islamic sects. The principal sunni inner sects are the hanafi, shafi’i, and hanbali schools. Over a broader field of differentiation are the sunni and shi’i schools of jurisprudence. Thereby, no standardization and harmonization could ever be determined by a mistaken approach to the identification of what truly is Islamic law. Is the law the shari’ah or is it the universal law of primal ontological origin in the Qur’an and which is also transmitted by the authentic sunnah into the knowledge of everything of the universal world-system? There will be consequences of the misinterpretation of the true primal ontological origin of the Islamic worldview if the law is avoided. The primal ontological law of the Qur’an, which is applicable to Muslims and nonMuslims alike and uniquely applicable to the realms of the animate and the cosmological world-systems, by abstraction and application, has been 24

DOI: 10.4324/9781003050209-3

T AW H I D I N D E X O F G L O B A L W E L L - B E I N G

avoided. In place of this primal ontological law of monotheism called Tawhid in the Qur’an, a distorted picture has been placed in what came to be defined as the shari’ah by the misinterpretations of clerical and theological differences. A great divide thus exists between the meanings of Tawhid and shari’ah caused as it has been by the vagaries of human desires, political interests, and commercial interpretations in differentiating religious interpretations. An example in this regard is the legitimation of shari’ah commercial instruments as separable contracts (‘aqd), contrary to the unified integrated understanding of financing instruments under the Tawhidi methodological worldview of unity of knowledge that interactively integrates and simulates possibilities across unifying systems.

3.2 A brief review of the critical literature: Tawhid as universal law contra shari’ah Shari’ah has remained in its narrow pale of legal contracts of worldly things (fiqh al-muamalat), contrary to the greater domain of studying worldly matters, abstractions, and evidences of the generality of universal categories (e.g. cosmological entities) (Choudhury, 2015). Indeed, on this critical issue, Buchman (1998, p. xviii)) writes regarding the prevalence of the Tawhidi worldview in the medieval Islamic age differently from those who have failed to understand the res cogitans and res extensa of the Tawhid weltanschauung: “… It (the book, Ghazali’s Niche of Lights) may be helpful to elucidate the general ‘Tawhid-centered worldview of 12th-century Islam’. People today – Muslims and non-Muslims alike – usually hold drastically different assumptions on the nature of existence than those held by al-Ghazali and most of his contemporaries”. On the topic of development indexing, the shari’ah remains as an ‘aqd (separable legal contracts); Islamic attempts to formulate such development indexing have missed the treatment of the systemic relational organism that sustainability essentially draws out of the episteme of unity of knowledge. The consilience of being and becoming (Prigogine, 1980; Wilson, 1998) is a physical model prototype of unity of knowledge. The algorithmic but not the substantive meaning of the Tawhidi methodology of unity of knowledge is formally represented by the consilience model. Yet on more significantly using these analytical models, the Tawhidi methodological worldview of pervasive unity of knowledge with moral induction gives the scheme and order of all unified developmental entities. These are not comprehended either by the idea of biological consilience or the shari’ah approach. What the shari’ah approach has tried to formulate are humanly selfassigned coefficient values to variables of the development index. A deconstruction of the aggregate index of well-being governed by the purpose and objective of the shari’ah termed as maqasid as-shari’ah, has been tried but the limits of deconstruction face the problem of differentiated categories 25

M asudul A lam C houdhury

among the indexes, indicators, and variables and their relations. Thereby, the exogenously assigned numerical values of the coefficients makes the whole indexing exercise to be a personated design, not a natural objective criterion. Along with such problems there is the serious one regarding the structure of the development index. Most often linear forms are used but without a basis of such derivations (Mustafa, 2016; Syed & Hasan, 2015). At the end, the shari’ah development indices have remained void of formulating the endogenous embedding of moral and ethical values of the Qur’anic genre in the representative variables of the material goods, services, and cognition by abstraction and applications. The latter is the design of the Tawhidi methodological worldview. We now turn to this substantiation of the well-being function criterion as the groundwork for the development index.

3.3 Tawhid as the primal ontological law contrary to the human imprecision of the shari’ah approach 3.3.1 Tawhidi-based well-being indicators Figure 3.1 provides the difference in methodological views between the primal ontological law of Tawhid unity of knowledge and the fiqh approach to the shari’ah. The details of the two methodologies are explained in respect of the generality of the endogenous moral embedding in representative variables for Tawhid and the impossibility of this by shari’ah as conveyed by the exogenous treatment of moral values. The Tawhidi methodological worldview (monotheism) as the primal ontological law of unity of knowledge invokes the Qur’an and the sunnah in their

Figure 3.1 Tawhidi Methodological Worldview Contrasted with Shari’ah in Practice.

26

T AW H I D I N D E X O F G L O B A L W E L L - B E I N G

purest form as the supercardinal topology of fullness of knowledge in the open and unbounded domain of Ω (Qur’an) at Point 1 in Figure 3.1. Elements of Ω as such a complete topology of knowledge is mapped by ‘S’ (sunnah as the teaching of the Prophet Muhammad) to generate knowledge-flows of the generality and particulars of issues and problems under study in diverse world-systems. Because ‘S’ is inextricably linked with Ω as a well-defined topological mapping to derive knowledge from the ultimate ontological source, we write this relationship as, [Ω → S: (Ω, S)]. Point 2 in Figure 3.1 shows the derivation of interpretive knowledge. Thereby firstly, {θ*} is derived from Ω by the ontological function of (Ω, S) [Qur’an (4:59)] O you who have believed, obey Allah and obey the messenger and those in authority among you. and if you disagree over anything, refer it to Allah and the messenger, if you should believe in Allah and the last day. that is the best [way] and best in result. We thereby write, (Ω, S) → {θ*}. Furthermore, from {θ*} by discourse concerning the issues and problems under construction, the participants of this interactive process arrive at a consensus (integration) to determine a given station of unification of knowledge of the interpretive derivation from (Ω, S) → {θ*}. This worldly derivation of unity of knowledge for induction in the unity of the generality and particulars of the world-system under study is denoted by {θ} as knowledge-flows from the primal ontological foundation. We thereby write, (Ω, S) →{θ*) → {θ}, for ∀ tuple {θ*, θ} ∈ (Ω, S) along with relational transformations of {θ*, θ}. The derivation of such diversity of {θ*, θ} from the primal ontology of supercardinal topology Ω by way of the topological mapping ‘S’ (Maddox, 1970; Rucker, 1982), is the epistemology that is induced as a moral organism into the variables and their relations representing the generality and specifics of the issues and problems under study. Thereby, the representative variables, {X(θ)} are simultaneously and continuously determined along with the continuity of {θ} as derived knowledge-flows of the nature of Tawhidi unity of knowledge. Thereby, knowledge-flow ‘θ’ induces all functional transformations in its various relations. Thus, the moral embedding of the world-system is denoted by {X(θ)}. The world-system that is spanned by the embedding of knowledge-flows arising from the ontology of the unity of knowledge and its epistemological processes out of discourse and interpretation are denoted by {θ, X(θ)} and its family of knowledge-induced embedding as moral transformations of the generality and particulars of the world-system. The coterminous determination of knowledge from the primal ontology of Tawhidi unity of knowledge and its epistemological derivation of knowledge-flows and knowledge-induced world-system completes the construction of the totality of the moral and ethicized world-system and its particulars. This event of the world-system occurs at Point 3 in Figure 3.1. 27

M asudul A lam C houdhury

The evaluation of the morally constructed world-system in terms of the epistemological consequences of Tawhidi ontology of unity of knowledge is carried out by the objective criterion of the world-system and its particulars. This objective criterion is the well-being function denoted by W(θ, X(θ)). It is referred to in Islamic terminology as maslaha. Along with the possibility of multiple transformations of {θ, X(θ)}, the family of monotonic positive transformations denoted by {W(θ, X(θ))} follows. At Point 3 in Figure 3.1, {W(θ, X(θ))} is evaluated in response to the features of the Tawhidi ontological and epistemological properties. That is {(θ, X(θ))} are characterized by discursive processes of interaction (I), integration (I), and evolutionary (E) learning (IIE) of the knowledge derivation and knowledge-flows in unity of knowledge. Such processes occur between agents, agencies, and organisms. All these are explained in terms of the knowledge-induced symbolic variables. The consequential organic unity of knowledge between such variables in abstraction and empirical applications is explained in a system of inter-causal relations. The Qur’an refers to such evolutionary learning dynamics as re-origination (khalq al -jadid) through the participative and complementary organically unified processes of ‘pairing’ (azwajaha kullaha). Qur’an (30:11): “It is God Who begins (the process of) creation; then repeats it; then shall you be brought back to Him.” Also note: Qur’an (36:36): “Glory to God, who created in pairs all things that the earth produces, as well as their own (human) kind and (other) things of which they have no knowledge.” Qur’an (51:49): “And of every thing We have created pairs: That ye may receive instructions.” Point 3 in Figure 3.1 thus summarizes the functional forms of the design of objectivity of the ontologically unified knowledge-embedded worldsystem in terms of the circular causation relations as formalized. Since unity of knowledge as complementary participation exists everywhere and in everything (Barrow, 1991), there is likewise the well-defined relationship of knowledge as the monotonic positive derivation of well-being measured in ‘θ’, while its conceptual but non-measurable form is given by W(X(θ); t(θ)). Point 4 in Figure 3.1 is the point of evolutionary learning that completes in any IIE-learning process the abstraction followed by the functional ontology of formalism, and its evidential evaluation. Phenomenology as the evaluation of organically unified systems brings together the three important evaluative points. These are, conceptualization of well-being, its systemic evaluation, sustained continuity of the same types of IIE-processes across events, and history of system ensemble (Hubner, 1985) in knowledge, space, and time dimensions. The study of socio-scientific consciousness is therefore the completion of abstraction followed by evidential evaluation. The term evaluation here means firstly, the straightforward estimation of the well-being function subject to circular causation of the inter-variable relations. Secondly, this estimation is followed by the simulation of the 28

T AW H I D I N D E X O F G L O B A L W E L L - B E I N G

coefficients of the estimated equations including the estimation and simulation of the quantitative form of the well-being function as shown in Figure 3.1. Simulation is a process estimation with changes in the coefficients to increase the possibility of ethically reconstructed inter-variable causal relations rising from weaker and negative coefficients into stronger and positive ones. This transformation of the relations would imply enhanced levels of participative complementarities between the variables representing the good things of life (life-fulfilment needs). The well-being function is now defined as the phenomenological complete indicator of levels of unity of knowledge between the knowledge-induced variables that characterize the well-being function, its simulation possibility, and the analytical interpretation of the estimation and simulation results. This holistic meaning of phenomenology in the Tawhidi methodological worldview of unity of knowledge is sustained across IIE-learning processes over the dimensions of knowledge, space, and time. The evaluated coefficients represent the automatically generated so-called shari’ah indicators corresponding to the selected variables of the well-being function. They exist in inter-causality and convey both actual states of the well-being indicators and the potentially simulated ones as predictors that are generated by means of a combination of primal ontological researching, discourse by way of Islamic consultative (IIE-learning processes), and statistical algorithmic evaluation. Fiqh reference to innovation and traditional shari’ah (Asad, 1987, p. 23): By far the larger part of those supposedly shar’i laws is an outcome of the deductions and the subjective reasoning of the great fuquha of our past – deductions and conclusions, to be sure, conscientously based on the context of the Two Sources, but none the less subjective in the sense that they were determined by each faqih’s individual approach to, and individual interpretation of, problems not laid down unequivocally, in terms of law, in either of those Two Sources. On continuously revisiting the Tawhidi primal ontological law and unity of the grand design (1987, p. 24), “… No subjective deduction, interpretation or conclusion touching upon any problems of law arrived at by means of the ijtihad (individual reasoning) of any, even the greatest, Muslim scholar can even be binding on the community.” 3.3.2 Shari’ah-based indices Within the Tawhidi methodology explained in Figure 3.1, shari’ah dynamics is explained by the process starting from Point 2 onwards. Yet, a dissociative break occurs at several places repeated along the Tawhidi String Relations (Figure 3.1). The problem of fiqh and shari’ah starting from Point 2 was stated in the words of Asad in a footnote. This problem has deepened 29

M asudul A lam C houdhury

and continued in present-days’ commercial practices according to different Islamic theological schools and sects. The problem of ‘aqd as opposed to the Tawhidi foundation of monotheistic unity of knowledge appears at each of the points. Point 1 is never addressed primally. Yet this is the command of the Qur’an. Qur’an (2:117): “To Him is due the primal origin of the heavens and the earth: When He decreeth a matter, He saith to it: ‘Be,’ and it is.” Hence the shari’ah approach remains without an ontological and epistemological foundation. The foundational methodology of the Tawhidi worldview in the Qur’an and sunnah is ignored by the differences of human interpretations concerning shari’ah. Consequently, the organic relations of unity of knowledge leading to circular causation and the complementary perspective of the objective criterion of well-being is abandoned. The ethics of such relations as organic inter-causality does not appear in any of the organic substantiation of the shari’ah. Thereby, the shari’ah indicators remain separable and non-integrated. Shari’ah does not bear Point 4 and remains unable to embed morality and ethics arising from the Tawhidi methodological worldview into interacting, integrating, and evolutionary learning variables. The concept of phenomenology as consciousness as explained at Point 4 in Figure 3.1 remains absent in the human mechanism of the shari’ah. All the above problems of the human interpretation in the shari’ah cause the shari’ah indicators to be wishful ones with no methodological and sustainable implications of Point 5 regarding continuity. Thereby, the intertemporal nature of development and well-being indicators fails to exist in the human mechanism of the shari’ah as well (Bank Negara, 2016). The shari’ah indicators fail to implicate the moral and ethical embedding as in {X(θ)}; therefore, the endogenous nature of inter-variable causality remains absent, contrary to the pervasively endogenous nature of complementarities between moral/ethical and cognitive variables. The permanent existence of exogenously treated morality and ethics in the ‘aqd-legal based perspective of shari’ah as engineered by human understanding fails to bestow uniqueness and universality to the shari’ah indicators of spirituality. The failure thereby to create a well-defined and significant knowledgeinduced variable {X(θ)} means that, spirituality indicators as defined indispensably by embedded qur’anic values by endogenous and conscious treatment remain absent in the human concocted shari’ah rules.

3.4 Islamic spirituality index: universality and uniqueness Islamic spirituality to be globally universal and unique in abstraction and application must be inextricably endowed by the following properties: 1

The body (X(.)) and the soul (‘θ’) to make the endogenous knowledge embedding in {X(θ)} and its various positive monotonic transformations 30

T AW H I D I N D E X O F G L O B A L W E L L - B E I N G

2

3

4

must well-define the abstraction and the empirical and analytical applications possible. The spirituality in cognitive details is thus ingrained in generality and details in the issues and problems of the investigated world-system. In Islam, the universal and unique foundation of spirituality is the monotheistic ontological law of unity of knowledge. An example of such a world-system and its global indicator for evaluation by the well-being function is the development index of sustainability. Thereby with (1), the universal objective criterion of well-being must be specified in the framework of inter-causal organic unity of knowledge as the foundational meaning of balance and life-fulfilling multidimensional values. The universality of such development and well-being indicators is explained by the interactive, integrated, and evolutionary learning intervariable organic unity of being and becoming by the ever-expanding sequences of variables. There is no need in such a globally universal concept of development and well-being indicator of spirituality caused by the pervasive presence of {X(θ)} to limit variables to selective attributes, such as justice, consciousness, goodness, balance, and neighbourly values (Commission on Global Governance, 1995). There are far more value-induced variables to comprehend in abstraction and application with the simulational expansion of the evolutionary learning of inter-causal processes. Uniqueness of the development and well-being criterion of spirituality is established firmly on the primal ontological law of Tawhid and its moral construction of the issues and problems of the world-system.

The spirituality index of development in well-being is devoid of exogenous separability between the socio-economic variables {X} and its essential embedding by {θ}. The unity of body and soul is formalized by Dewitt in his, Supermanifolds, Cambridge, England: Cambridge University Press, 1992. 1 2

Figure 3.1 shows that multi-systemic indexes are integrated together in the well-being function. Thus, at the end, the evaluated well-being function in abstraction and applications forms the universal and unique objective criterion of spirituality in Islam. From this general objective criterion, specific derivatives of indexes can be derived out of the circular causation relations.

3.5 Sprituality indices of development and organizational behaviour in endogenously unified world-system of well-being, maslaha Development indexes are defined by UNDP (2020) as Human Development Index in terms of separable indicators, such as the Human Development 31

M asudul A lam C houdhury

Index by countries (hc), Poverty indexes 1 and 2 by countries (PIc), Gender Empowerment Index (GEMc), Happiness Index by countries (Hc), and Corruption Index by countries (CIc). To adds to these is the Millenium Development Index by countries (MDc). The vector of development indexes is thereby, Dc = {h, PI, GEM, H, CI, MD}c. Let the organizational decision-making index by preferences for each of the development indicator (dc) for each country be defined by {ρdc} (Simon, 1987). The above two sets of indices are included in the well-being function by its detailed properties of interaction, integration, and evolutionary learning (IIE-learning properties). As shown in Figure 3.1, two systemic well-being functions, one for development and another for organizational decision-making can be generated by similar IIE properties. Let these well-being functions be, Wdc(Dc(θdc)), and Worg({θdcorg}). The compound well-being function is given by Wdc(Dc(θdc))·Worg({ρdc(θdcorg)} = W(Dc(θdc), {ρdc(θdcorg)}). The development variables and organizational variables as shown and further disaggregated by the inner socio-economic variables are inter-causal in nature. Hence, the circular causation relations in the evaluation of the inter-systemic variables exists to explain the inter-variable causality of the endogenous nature of organic relations relating to the unity of knowledge. The intermeshing of the data in the vector, (Dc(θdc), {ρdc(θdcorg)}), can be done between time-series data for Dc(θdc), and non-parametric data for {ρdc(θdcorg)}. See below for the data inter-meshing method. The variables in these vectors are related by circular causation relations as shown in Figure 3.1 across countries ‘c’. The unifying knowledge-inducing variable is the measured form of the well-being function. In the total number of circular causation relations, the quantitative form of the well-being function takes the functional form across the two domains of Dc and dcorg, θ = Avg(θdc, θdcorg). The compound well-being function is now given by, θ = F(Dc(θdc), ρdc(θdcorg))[θ]. Furthermore, a wider aggregation of the spiritually induced index for the global order can be formalized for the interdependent countries in terms of their variables and ordinalized degrees of complementarities of unity of knowledge between the country-specific variables globally. We denote the resulting well-being function in terms of the development and organizational preference variables forming indices of the interdependence between development sustainability and organizational preferences in decision-making.

3.6 Conceptual and quantitative forms of spiritual index as well-being function evaluated subject to circular causation in development and preferences Evaluation of W(θ) = W(D, ρ)[θ] gives the compounded aggregation over ‘c’ and their interdependent socio-economic and preference variables all 32

T AW H I D I N D E X O F G L O B A L W E L L - B E I N G

Figure 3.2 Spiritual θ-Embedded Development Indices and Organizational Intercausal Indices Derived from the Objective Criterion of Evaluating the Well-being Criterion.

induced by ‘θ’, as shown above. Because of the IIE-learning process nature of preference formation we can write the aggregate dynamic social preference as, ρ(θ) = ∪I, interaction ∩I, integration {ρdc(θdcorg)}I, I; with evolutionary learning, d{ρ(θ)}/dθ > 0 in respect of the interdependence between socio-economic variables, wherein, ρ(θ) = f(D(θ)). The circular causation relations are, Di = f i(Dj, ρ); ρi = g i(D, ρj), i ≠ j = 1, 2, …., and finally, there is the quantitative form of the well-being function, θ = F(D, ρ)[θ], as a monotonic positive derived functional of W(θ) = W(D, ρ)[θ]. Figure 3.2 explains the country-specific and global (suffixes are suppressed) nexus of systemic interrelations between the development and organizational variables in the well-being criterion. Such complementary interrelations in the framework of organic unity of knowledge is attained in and by the well-being function in terms of the relational variables of the Tawhidi index of well-being as this was defined earlier as the true and principal Islamic index of spirituality in terms of θ ∈ (Ω, S). 3.6.1 Addendum: data inter-meshing between time-series and primary questionnaire survey results Data inter-meshing between time series and cross-sectional/survey data at a given point of time is a mathematical undertaking under simplifying assumptions. It is assumed firstly that survey responses to questionnaires on Islamic ethical attributes remain unchanged over a given period corresponding to the statistical time-series data. Secondly, the average value of the attribute-ranks calculated based on non-parametric responses (say θ′) denotes the quantitative measure of well-being based on the nonparametric evaluation of financial data via survey results. Thirdly, the quantitative measure of well-being based on time-series data denotes the average of the data-ranks estimated based on the time-series data. This is denoted by ‘θ’. Fourth, with the ‘θ’ index as the quantitatively estimated well-being function, there are the individual time-series generated ‘θt ’values. Fifth, the number of attributes is devised to be the same as the number of parametric values. This is acceptable as the attributes are surveyed corresponding to the specific parametric values and averaged within 33

M asudul A lam C houdhury

each such group. Sixth, Avg(θ) and Avg(θ′) correspond to the row-specific (θt, θA)-values/responses. The following strip of the detailed table of inter-meshed data is shown below: Parametric time-series data {θ, x(θ)} Non-parametric attributes data (θ*, A(θ*)) Time x1θ1, x2θ2 … x nθn Avg(θt) = θA1θ′1 … Anθ′n Avg (θ′) = θ′ t = 1, 2…., T at a point of time of survey questionnaire We ask the statistical question: How dispersed are the average values of (θ, θ′)? Value – to tally the authenticity of the well-being results estimated from the parametric and non-parametric sides. The smallest value of the dispersion indicator nearest to zero gives the best result. Dispersion indicator = |(θ − θ′)| θ′ remains constant for the non-parametric formula. If we take all the terms in natural logarithms, then in the coefficient form of the quantitative estimated well-being function expressed in natural logarithmic θt and θ′ values, the following expression holds: Dispersion indicator = Σt = 1Tαt·lnxt − lnθ′

References Asad, M. (1987). This Law of Ours. Gibraltar: Dar Al-Andalus. Bank Negara. (visited Aug. 2016). http://www.bnm.gov.my/guidelines/01_banking/ 04_prudential_stds/07_shariah_resolution.pdf. Barrow, J.D. (1991). Theories of Everything, the Quest for Ultimate Explanation. Oxford: Oxford University Press. Buchman, D. (trans.) (1988). Al-Ghazali Niche of Lights. Provo, UT: Brigham University Press. Choudhury, M.A. (2015). “Res extensa et res cogitans de maqasid as-shari’ah”, International Journal of Law and Management, 57(6), 662–693. Dewitt, B. (1992). Supermanifolds. Cambridge: Cambridge University Press. Hubner, K. trans. by Dixon, P.R. Jr. & Dixon, H.M. (1985). “Foundations of a universal historistic theory of the empirical sciences”, in Critique of Scientific Reason, pp. 105–122. Chicago, IL: The University of Chicago Press. Maddox, I.J. (1970). Elements of Functional Analysis. Cambridge: Cambridge University Press. Topological concepts are given here. Mohammed, M.O. & Taib, F.M. (2016). “The performance measures of Islamic banking based on the maqasid framework”, Chapter 5 in Choudhury, M.A. (ed.) Islamic Financial Economy and Islamic Banking, pp. 94–113. London: Routledge. Prigogine, I. (1980). From Being to Becoming. San Francisco, CA: W.H. Freeman.

34

T AW H I D I N D E X O F G L O B A L W E L L - B E I N G

Report of the Commission on Global Governance. (1995). “Global civic ethic”, in Our Global Neighbourhood, a Report of the Commission on Global Governance, pp. 55–67. New York: Oxford University Press. Rucker, R. (1982). “Large cardinals”, in Infinity and the Mind, pp. 253–266. New York: Bantam Books. Simon, H. (1987). “Decision making and organizational design”, in Pugh, D.S. (ed.) Organizational Theory, pp. 202–223. Hammondsworth: Penguin Books. Syed Ali, S. & Hasan, H. (2015). Towards a Maqasid al-Shari’ah based Development Index (No. 1435-18). United Nations Development Program (UNDP). (2020). Human Development Report. New York, http://www.hdr.undp.org/. Wilson, E.O. (1998). Consilience, Unity of Knowledge. New York: Vantage Press.

35

4 RISK MANAGEMENT AND RISK SHARING IN ISLAMIC FINANCE Theory and practice Rodney Wilson 4.1 Introduction Risk sharing is an essential characteristic of Islamic finance, as it is integral to the moral principle of bearing each other’s burden.1 It implies social solidarity rather than the pursuit of selfish individualistic gain at the expense of others. Risk cannot be avoided as it is inherent in economic and commercial relations and business cycles have always occurred; indeed, they were identified by the great Muslim philosopher of history Ibn Khaldun in the 15th century. He studied the causes of the rise and fall of all great empires with the upswing associated with strong moral leadership and law and order, creating firm foundations for economic expansion. In contrast, the downturn was characterised by corrupt governance and uncertainty.2 While businesses cannot isolate themselves from these macroeconomic developments, risk sharing can help mitigate some of the negative effects. The techniques of risk management aim to ensure that debt is sustainable and that clients can meet their financial commitments ensuring that financial institutions do not have to write down the value of their assets. There are many techniques for risk management, the most popular being credit scoring, which takes account of the income, existing debts and assets of the client.3 Risk management can facilitate risk sharing as an objective quantification of the ability of the client to take on debt lowers risk for both parties. Nevertheless, there are negative implications of credit scoring, with those on low and volatile income and few, if any, assets classified as unfit to benefit from commercial financing. In other words they may face financial exclusion, while those with high incomes with substantial assets are prioritised to receive financial backing.4 This may result in increasing income and wealth inequalities, worsening an already unjust distribution of credit. As Islamic banks and other shari’ah-compliant financial institutions use the same techniques for risk management as conventional institutions, they are 36

DOI: 10.4324/9781003050209-4

S H A R I NG A N D M A NAGI NG R I SK I N I SF

also contributing to worsening income and wealth disparities, undermining their moral purpose. This research explores the dilemma resulting from conservative risk management, with a potential conflict between moral objectives and the realities of both Islamic and conventional financing. Different types of risk are examined from the prospective of risk management and risk sharing, notably credit risk, liquidity risk, operational risk, macroeconomic risk, and finally, but not least, reputational or shari’ah risk. In addition to discussing risk management in Islamic banking from a theoretical and conceptual perspective, the financial reporting of leading Islamic banks is examined. The institutions covered include Dubai Islamic Bank, Riyadh based Al Rajhi, Maybank Islamic of Malaysia, and Meezan Bank, the leading Islamic bank in Pakistan. It is evident that there are major differences between these banks with respect to risk management. These institutions could learn from their collective experiences in adopting risk-management strategies. Risk-management guidelines from the Islamic Financial Services Board (IFSB) are also discussed as well as the recommendations of the State Bank of Pakistan.

4.2 Credit risk The major risk facing conventional banks is credit risk, where borrowers do not honour their loan obligations, either because of a failure to make interest payments, non-repayment of principal, or both.5 Islamic banks do not provide loans and there are no interest charges, but payment charges in the form of profit mark-ups and rent have to be honoured under Islamic financial contracts as well as repayments of cost. Similar risk assessments have to be made by both conventional and Islamic banks when deciding whether or not to provide the finance needed by clients to support their project proposals.6 If finance is provided and clients default, this may have serious implications for the banks, as assets will have to be written down or written off, which will force banks to reduce their liabilities. If depositors believe the bank is in difficulty, they may withdraw their funds, in extreme cases causing a run on the liquidity held by the bank. Hence credit defaults may cause contagion by increasing other types of risk, especially liquidity risk. Islamic banks have a moral purpose, and their objective is to facilitate shari’ah compliance in financial transactions rather than simply to make money for their shareholders and management. Obviously, they must respect and adhere to the teaching of the Holy Quran, including that on the late settlement of funding obligations due to genuine financial difficulties. If the debtor is in difficulty, grant him time till it is easy for him to repay. If ye remit by way of charity; that is best for you, if ye only knew. (Sura 2:280) 37

R odney W ilson

Practical measures to apply this teaching include the rescheduling of debts but using the same financing method and terms with no penalty to borrower.7 The bank will of course experience negative effects on its income flow, but it will not have to write down the value of its assets unless the delay extends to a lengthy period where regulatory rules dictate asset devaluations. Regulators may be prepared to exempt Islamic banks from stringent rules on asset management if they believe the bank’s clients will honour their obligations in the longer term and become creditworthy again. Islamic banks may even be willing to swap existing obligations for a qard hasan loan without interest.8 Again this may lengthen and reduce cash inflows to the Islamic bank, but this will be preferable to asset write-offs. Of course, the circumstances of some clients may turn worse due to illness or unexpected family obligations. The Islamic bank may decide on a case-by-case basis whether remission of debt is justified with the client excused from further financial obligations. This will of course cause losses for the Islamic bank, but remission may bring goodwill from other clients and help the bank win business in the longer term because of its moral and sympatric behaviour.

4.3 Moral hazard There are moral hazard challenges with Islamic banking, notably with profitsharing contracts such as mudarabah and musharakah, where profits may be under-reported by client businesses reducing the margin accruing to the bank. Conflicts over insider and outsider rights are common in financial mediation, and where returns are determined by one of the parties, as in the case of profit-sharing contracts, there is a temptation to deceive. There may be asymmetric information with the client knowing their own business best while the bank inevitably has less detailed knowledge even where the finance is participatory, as is the case with Islamic banking.9 There is a high degree of trust in Islamic finance, but this can be abused. If clients view the bank as helpful rather than as exploitive, they are less likely to conceal their financial position. Where the bank and the clients have common values and share a faith, as is the case with Islamic banking, there is a bond with the clients being loyal to the institution. Peer pressure can make borrowers acknowledge their responsibilities, with much goodwill shared by the clients to each other.10 Community-based Islamic banks and micro-financing institutions are especially effective in creating a culture of solidarity, where honesty is the norm.11 Inevitably, there will always be some clients who seek to disregard their financial obligations even when they have sufficient funds to pay. A distinction is made in Islamic teaching between those that “cannot pay” compared with those who “will not pay”, or in other words between those facing real hardship versus unscrupulous defaulters. If there is no penalty for deliberate late payments because this would involve charging riba, then there is a 38

S H A R I NG A N D M A NAGI NG R I SK I N I SF

danger that Islamic finance could be abused, with Islamic banks seen as a soft touch in comparison with conventional banks that have no hesitation about applying interest penalties. In practice, Islamic banks can put pressure on deliberate defaulters through a variety of non-financial penalties, the most common being the blacklisting of defaulters by passing on their names and contact details to a register with the central bank. This prevents those in breach of contract from obtaining funding from other banks. An even greater deterrent is where redress is taken through the courts that may result in the defaulter being declared bankrupt or, in the most extreme cases, the defaulter having their passport confiscated or suffering imprisonment. Financial penalties are also possible, provided the proceeds from any fine made for late payments are donated to charity, with no financial gain permissible for the Islamic bank. Collateral provides a safeguard for much Islamic financing, as, in cases of default assets, can be sequestrated. With murabahah and ijara, the acquisition and use of real assets is being financed. These can be seized in the event of a default, but the assets may not be worth much to a financier, as their resale value is limited, especially if they were made specifically for clients to specifications, which may not be valued by others. Personal financing for vehicles or home purchase is usually only provided to clients who have their salaries being directly paid into the bank that is making the advance. In the case of defaults, the bank can impose limits on personal access to salary until bank claims are met.

4.4 Liquidity risk Regulators worldwide have strict criteria for how banks should manage liquidity as a buffer is required to ensure that all withdrawals by depositors can be honoured. A loss of confidence in a bank may result in a run on deposits and if the bank has insufficient resources, the central bank may have to compensate depositors, with the ultimate costs in the case of a banking collapse being borne by taxpayers. Most countries provide deposit guarantees with banks obliged to insure their deposits, which reduces the potential burden on the government. In the case of Islamic banks, demand deposits are guaranteed in the same way as their conventional equivalents.12 The value of investment deposits with Islamic banks is not guaranteed, however, as under mudarabah contracts, depositors, who are regarded as partners, must agree on bearing a degree of risk to justify their profit shares. In contrast, savings depositors with conventional banks have their deposits guaranteed while receiving interest returns, but do not have a partnership status. From a regulatory perspective, the difference in deposit liabilities between conventional and Islamic banks does not warrant any concessions on liquidity requirements.13 Although the investment depositors are partners, 39

R odney W ilson

there is no provision for them to inject additional deposits to cover any run on liquidity. Investment mudarabah deposits are usually subject to notice periods for withdrawals, which reduces liquidity on demand, but this also applies to savings accounts in conventional banks with tiered levels of interest. Even if there was a theoretical case for less liquidity given that mudarabah deposits are not guaranteed, in practice, these depositors rarely, if ever, take a hit with the value of their deposits written down. Indeed, if the bank is performing badly with lower or no profit shares paid to investment depositors, they may be likely to withdraw their funds. In contrast, the interest on savings accounts with conventional banks will vary according to macroeconomic conditions rather than being institution-specific, which brings greater risks of runs on deposits. There is some contrary evidence, however, that because Islamic investment depositors tend to treat mudarabah accounts as long-term savings, the velocity of circulation of these accounts is exceptionally low, reducing the need for liquidity cover.14 Islamic banks mostly comply with Basel III liquidity standards that specify that all banks should have sufficient liquidity to cover one month of deposit run-offs. This reflects an assumption that deposits in retail banks are subject to a monthly cycle with most salary earners having these credited automatically by employers and the account holders using these funds to pay monthly mortgage instalments, utility bills, credit card balances, insurance, and other regular outgoings.15 Many investment account holders with Islamic banks also have demand deposits with conventional banks that they use for everyday transactions. It is these that have the substantially higher velocity of circulation and arguably, therefore, greater reserve liquidity needs. Conventional banks hold a major proportion of their liquid assets in treasury bills, which are guaranteed by the government and pay a modest interest. As there are active markets in treasury bills, banks can move from cash to bills or vice versa according to changing liquidity needs. Islamic banks cannot hold treasury bills that pay interest, and as an alternative, they hold special central bank deposits that pay no interest, the attraction in return for these holdings being that they are provided with interest-free loans from the central bank as required.16 This is a key tool for shari’ah-compliant treasury management, the others being murabahah inter-bank deposits and shortterm sukuk. The deposits placed in murabahah accounts with other banks are used to finance commodity transactions, with the placement used to purchase a commodity that is subsequently sold to a third party at a higher price, the resultant profit being shared by the two banks. Providing legal safeguards to the participants is expensive, however, resulting in a decline in the use of this tool for liquidity management. More popular are short-term sukuk, usually structured as an ijara contract, where the bank invests in an asset and receives a rental income. If the sukuk are traded in a secondary market, this provides an exit route for the bank into cash without waiting 40

S H A R I NG A N D M A NAGI NG R I SK I N I SF

for the sukuk to mature. Only Malaysia has a highly active and liquid sukuk market.17 The low volume of sukuk trading elsewhere, even in Saudi Arabia and the Gulf, discourages Islamic banks from using sukuk securities for liquidity management. Liquidity risk arises in all banks where there is a mismatch between assets, which are typically medium to long term, and liabilities that consist of demand deposits and short-term notice deposits. Balance sheet management can narrow the gap, on the liability side by the promotion of mudarabah notice deposits to reduce on-demand liability. Shortening the funding period to make assets mature more quickly can help, but this would amount to moving back to the years when most Islamic finance was short-term murabahah. Critics of this overconcentration urged Islamic banks to make finance available through longer-term contracts, including ijara contracts running for three years, or diminishing musharakah mortgages, often for periods of 15–20 years. Such contracts are inevitably riskier, as longer-term contracts mean greater uncertainty, but this was how Islamic banks were urged to move by their critics.

4.5 Control of operational risk Operational risks include fraud by bank employees and breaches of customer security, usually by hacking into the bank’s information technology systems.18 The aim should be to eliminate such risks, not to share them, as they constitute criminal activity that may severely damage the reputation of the financial institution and the interests of its clients. Security breaches are matters for the regulatory authorities, and ultimately the police, if criminality is involved. Of course, prevention is preferable to acting after the event, and banks themselves should invest more in their human resource and informational technology systems to ensure they are robust.19 As most Islamic banks are small to medium sized, they have fewer resources to invest in customer support systems and information technology firewalls than large conventional banks with millions of customers. Regulators and bank clients have high expectations, but there are economies of scale in support services, which results in small- and medium-sized Islamic banks being at a competitive disadvantage. There is particular concern with the adequacy of reporting systems as, in addition to the public accounts, a substantial amount of financial data must be supplied to the central bank. Given that the investment depositors are partners and share in the bank’s profits, a case can be made for producing dedicated information to serve their interest on business strategy. In addition, the release of relevant financial data on past and projected profits would arguably be useful for investment depositors. It can even be argued that investment depositors, given their unique stakeholder status in Islamic banks, should have representation on the board of directors. Islamic banks normally have a conservative 41

R odney W ilson

approach to corporate governance like their conventional counterparts but a more radical approach to broader stakeholder representation may be justified. The innovative nature of Islamic bank assets and liabilities requires special treatment in financial reporting, hence the development of the standards of the Accounting and Auditing Organisation for Islamic Financial Institution (AAOIFI).20 These enable comparisons between Islamic banks to be made in different jurisdictions. Having industry benchmarks facilitates risk assessment, especially when Islamic banks can be judged against their peers. On the financial liability side, the proportion of investment accounts to total deposits varies widely. High percentages of investment accounts reduce risk as more is shared, but it also increases the cost of funding given that profit shares must be paid. On the asset side, shorter-term finance, as with murabahah contracts, implies less risk, not least as the funding is for commodities, goods, and equipment. In contrast, long-term project finance, as with istisna contracts, implies supporting construction activity that is often subject to delays, lengthening still further the period before revenue is generated. In any business, trust in employees is crucial, as without this, risks are multiplied.21 Those appointed to positions in Islamic banks and financial institutions are often motivated by religious values, and they share a common ethos with their colleagues. To behave dishonestly or irresponsibly would be to let the team down and feel guilty for any misdemeanours or corrupt acts. The concept of amanah, or trust under Islamic teaching, should govern employee behaviour. Loyalty is paramount, and the highly motivated can contribute much to institutional success. Information technology risks are reduced substantially if data protection is taken seriously. Hacking into client accounts usually requires insiders providing confidential information to criminals. Islamic bank employees seek to stay clear of such corrupting influences.

4.6 Macroeconomic risk Islamic banks, like their conventional counterparts, have no control over macroeconomic risks that arise from government policies and the political and economic environment, both national and global.22 As Islamic banking is especially developed in oil-exporting countries, changes in oil prices affect government finances and business sentiment. Rises in oil prices usually result in more government spending, which serves as an economic stimulus. This creates more financing opportunities for Islamic banks. In contrast, falling oil prices imply less revenue for governments, resulting in fiscal deficits, which inevitably cause a squeeze on government spending, with fewer financing opportunities for Islamic banks.23 Even with reductions in state spending, there may still be government deficits that have to be financed by 42

S H A R I NG A N D M A NAGI NG R I SK I N I SF

borrowing. This will increase the costs of sovereign debt, as bonds will have to pay higher interest, and even if sukuk are used as a shari’ah-compliant alternative to riba-based bonds, investors will expect higher returns. In both cases, there will be a monetary transmission mechanism, whereby the cost of funding for Islamic banks increases as investment depositors get higher returns, which are passed on to clients who will have to pay increased markups for murabahah financing or higher rents with ijara contracts. Often fiscal deficits are accompanied by inflation, which is also reflected in the returns paid to investment depositors and the cost of Islamic financing, both being subject to upward pressure. With most Islamic finance, the terms are fixed in advance, which results in margins being reduced if inflation raises the returns to investment depositors, while the costs to the clients of finance remains constant. With murabahah contracts, no changes to the mark-up are possible as the finance is short term. Ijara contracts usually specify fixed rental payments, although in some cases, the rent is indexed to the inter-bank offer rate. As this is an interest rate, some Shari’ah scholars are uneasy about using such a benchmark, but as the payments are designated as rent, others regard the variable cost contracts as legitimate. Islamic financial institutions also must cope with exchange rate risk when assets and liabilities are denominated in different currencies. As far as possible, Islamic banks attempt to match currency holdings to minimise exposure to foreign exchange risk. Fortunately, as Gulf currencies are pegged to the United States dollar, in which most oil prices are denominated, this simplifies foreign exchange management. The problems arise with assets in currencies subject to frequent devaluation and depreciation such as the Turkish lira or Pakistani rupee. If Islamic banks in the Gulf offered financial contracts in these currencies, the value of any returns would be diminished, if not eliminated, by exchange rate depreciation. Islamic financial institutions based in the Gulf have established subsidiaries in less affluent but populous Muslim countries. It has been challenging for these overseas ventures to make much of a contribution to the consolidated financial position of the home institutions, as both the value of the assets and profits diminish year after year in terms of Saudi riyal or UAE dirham. The problem is not only the historical currency depreciation, but the uncertainty of the sustainability of the macroeconomic policy and the consequences for exchange rates.24 In the short-term, currency hedging may eliminate exchange rate risk but inevitably, at some cost, as the fixed rate quoted will usually be less than spot conversion. In Islamic jurisprudence, salam contracts can be used for hedging currencies, these were originally being used for agricultural commodities, which could be purchased three or even six months in advance of delivery with the payment used to finance inputs, including labour costs in advance of the harvest. Some forms of currency hedging are highly speculative, and hence incompatible with Islamic jurisprudence because of their exploitative nature, taking positions in futures markets being a prime 43

R odney W ilson

example.25 The purchaser of futures normally has no intention to take delivery of the currency, but sells the right to purchase at a fixed price on to other market participants. The value of the futures contract depends on how the spot market price changes, which amounts to a form of gambling with professional traders taking advantage of those who are less informed about currency developments.26

4.7 Shari’ah risk The scholars of Islamic jurisprudence invariably have different opinions, which results in a healthy discourse between members of shari’ah boards serving Islamic financial institutions. Although standardisation would simplify shari’ah governance, it would also stifle debate and fossilise Islamic jurisprudence. The foundational principles of Islamic teaching are of course unchanging, but these have to be applied in the context of rapid developments in contemporary finance. In the field of Islamic finance, more fatwa have been issued during the past three decades than in the previous thousand years, largely as a result of the growth of Islamic banking and the consequent increase in the number of shari’ah boards. Each Islamic financial institution appoints its own shari’ah board and their fatwa may differ between different jurisdictions or even between Islamic financial institutions within the same jurisdiction. In practice, shari’ah governance has been privatised, the alternative being for the Central Bank to appoint its own shari’ah board to standardise fatwa at national level, as is the case in Malaysia.27 At the international level, the AAOIFI Shari’ah Board issues standards on behalf of its members, but these are not binding and there is no mechanism for enforcement. Conflicting fatwa creates uncertainty and increases risk, especially with the issuance of the new fatwa, resulting in the former shari’ah-compliant contract no longer being valid. This can have negative financial consequences, an example being musharakah sukuk with a capital guarantee that were hitherto approved by shari’ah scholars but then declared invalid, as the guarantee meant that risks were transferred from sukuk investors to the originators seeking finance, which was seen as unfair. Returns to investors could not be justified without risk sharing as musharakah contracts imply partnerships with all parties bearing losses or making gains. Another example was tawarruq, a variant of murabahah that serves as a method of securing funding through a trading contract without the client wanting the commodity being financed. Rather the client sells the commodity to the financial institution for cash and repays by regular monthly instalments that include a mark-up for the financial institution. This transaction is like a conventional loan, but without interest. Some shari’ah scholars have ruled that tawarruq is legitimate as it involves a real trading transaction. Critics argue that the transaction is pointless, as the commodity trade is merely a 44

S H A R I NG A N D M A NAGI NG R I SK I N I SF

device to lend cash to a client and is substantially the same as an interestbased loan.28 The respect by clients for Islamic financial institutions is largely because of the reputation of the shari’ah board members. If the shari’ah scholars become discredited, it results in a damage to the reputation of the Islamic financial institution. It may even result in approved contracts being subject to litigation as with Investment Dar of Kuwait.29 Potentially the Islamic scholars could be subject to fines for negligence, a serious outcome given their lack of legal indemnity.

4.8 Risk mitigation With Islamic finance, the purpose of the funding is always specified in the legal contracts rather than the money being spent at the discretion of the borrower, as is often the case with conventional loans.30 Islamic banks usually become directly involved in the transactions being financed, with for example, in the case of murabahah, the bank purchasing the commodity, merchandise, or equipment on behalf of the client and then selling the acquisitions to the client who pays either a lump sum or more usually in instalments, which include a mark-up. The bank is temporarily the owner of the asset being financed, and therefore takes on the risks associated with ownership. Even when the asset is sold to the client, the bank still retains a residual ownership as first buyer. If the asset is defective, the bank could be sued by the client. In the event of a default by the client, the bank can retain ownership of commodity being financed, but may have difficulty finding a buyer, and it may be exposed to capital losses.31 In the case of ijara contracts, the bank has lessor responsibilities as the lease is an operating contract. If the property or equipment is defective, the bank is obliged to remedy the matter and it will be responsible for the insurance of the leased asset.32 From a regulatory perspective, there is some concern about Islamic banks taking an operational role under these financing contracts. If instead leasing companies provide ijara contracts, then their shareholders will take a hit if clients default, but Islamic banks have a substantial obligation to their depositors, with even those with non-guaranteed investment accounts hoping to avoid capital losses. In other words, Islamic banks must avoid excessive risk taking, as although this is valued by their clients seeking finance, there are other stakeholders to consider, notably the investment depositors. Conventional banks cannot enter partnerships with their clients, as this is also deemed too risky by regulators. Such partnerships are highly valued, however, by those involved in Islamic finance, as with musharakah contracts, the bank as a co-owner is obliged to share ownership responsibilities and potential losses.33 This is more risky than mudarabah where the investors as raab al maal bear all losses, not the bank as mudarib. Using diminishing 45

R odney W ilson

musharakah for Islamic mortgages reduces risks considerably as the bank is co-owner of the property and the regular repayments through instalments reduce the risk over time as the amount of debt decreases.34 In addition, with Islamic mortgages, the contractual pre-conditions for approval also further mitigate risk, notably that the client agrees on the repayments being made by direct debit from a current account or by standing order from an account into which the client’s salary is paid. The Islamic banks, like their conventional counterparts, also undertake due diligence including on the client’s employment status, whether employed or self-employed, their length of time in the present occupation and job security as well as their income level and variability with bonuses. Other debt obligations of the client and their servicing costs also form part of the appraisal. An independent valuation is required of the property as well as of any collateral pledged, and there may be provision for a possible revaluation if the financing is long term. The purpose of risk mitigation is to reduce risk, but this should not be seen as undermining the concept of risk sharing. Indeed, far from detracting from risk sharing, mitigation may make it more attractive as the exposure is reduced. There is no merit in taking on excessive risk, indeed such actions may be considered as reckless, even a form of gambling. Risk sharing is an act of solidarity, a matter of principle, rather than being about the precise calculation of risk. The ability of the poor to absorb risk is of course much less than that of the rich, but that should not preclude modest risk sharing by those on low incomes with few assets. In the sight of Allah, they will get an equal, if not higher reward for participation in risk than the rich who can afford to lose their wealth. The risk sharing by bank clients mainly involves investment deposits.35 It is of course the financial institution that plays the major role in risk management, not the clients. The banks themselves cannot manage all risks, as macroeconomic risk is beyond their control and is a matter for governments. Banks however, whether Islamic or conventional, must manage credit risk, operational risk, and liquidity risk. Poor management may result in losses for shareholders.36 What is different in the case of Islamic banks is the need to minimise shari’ah risk, but not in a way that stifles debate and innovative fatwa.37 Also unique to Islamic banking is the participation in risk absorption by investment depositors through mudarabah contracts. This may result in some risk reduction for shareholders. Ultimately the shareholders have an interest in the mudarabah depositors being adequately rewarded through their profit shares, as if in times of stress, dividends continue to be paid to shareholders while investment depositors receive no profits, the latter are unlikely to remain clients of the Islamic bank, threatening its survival. This may result in capital losses for Islamic bank shareholders as equity prices fall. Although the value of the investment deposits cannot be guaranteed they are generally, and correctly, regarded as safer assets than equity holdings. 46

S H A R I NG A N D M A NAGI NG R I SK I N I SF

4.9 Risk-management practice Islamic banks are subject to the same disclosure requirements as their conventional counterparts as the governments of most Muslim majority states have signed up to the Basel III Accords. These provide comfort to other banks, including Islamic institutions, that sovereign and bank risk exposure is being carefully managed. The increased capital adequacy and liquidity requirements under Basel III were the agreed responses to the global financial crisis of 2007–2008 to avoid the repetition of such disruptive and damaging events. Not surprisingly, Islamic bank financial reporting shows that institutions in open and highly globalised financial markets provide much more detailed reporting with greater transparency than those in more closed and protected markets. Dubai Islamic Bank is an example of best practice as it provides detailed data of great interest to analysts and researchers. Table 4.1 shows the risk-weighted assets for 2017 and 2018, most of which is accounted for by credit risk, while Table 4.2 gives the capital ratios, which will reassure counterparties. In the United Arab Emirates, strict adherence to Basel III requirements is practised to guarantee the stability of the financial system, including the Islamic banking sector. Islamic banking in Malaysia is also well regulated, with the quantification of risk exposure using the Basel III methodology. Table 4.3 shows the capital requirements for credit, market, and operational risk by the Malaysian subsidiary of Al Rajhi Bank, the largest Islamic bank in the world, which is based in Riyadh. Given its Malaysian experience of risk management, Al Rajhi plans to undertake similar estimations for the entire group. Priority has been given to staff training with the School of Banking at the Al Rajhi Table 4.1 Risk-Weighted Assets (AED’000)

Credit risk Market risk Operational risk Total

2018

2017

161,737,978 1,520,866 13,266,610 176,525,454

153,202,879 1,959,686 11,934,690 167,097,255

Source: Basel III Pillar Disclosures, Dubai Islamic Bank, 2018.

Table 4.2 Capital Ratios

Capital adequacy ratio Tier 1 capital ratio Common equity tier 1 ratio DIB Pakistan

2018 (%)

2017 (%)

17.5 16.3 12.4 14.0

15.3 14.2 9.8 13.4

Source: Basel III Pillar Disclosures, Dubai Islamic Bank, 2018.

47

R odney W ilson

Table 4.3 Risk-Weighted Assets (RWA) and Capital Requirements (CR), (RM’000)

Credit risk Market risk Operational risk Total

RWA 2017

CR 2017

RWA 2016

CR 2016

6,146,694 126,272 333,360 6,606,326

491,735 10,102 26,669 528,506

5,569,081 122,785 329,719 6,021,585

445,526 9,823 26,378 481,726

Source: Basel III Pillar Disclosures, Al Rajhi Bank, Malaysia, 2017.

Academy providing a course on enterprise credit risk management during December 2019 in partnership with Moody’s Analytics. There has also been academic research into how the Al Rajhi Group performed during the financial crisis.38 Maybank Islamic is part of the Maybank Group, the leading bank in Malaysia. Although the Group largely provides conventional banking services, the Islamic subsidiary is fully shari’ah compliant. Exposure ratios are calculated for the Group as a whole, as the resources of the Group could be used to keep each constituent afloat in the event of a credit crunch or a liquidity crisis. Purists however worry about the implied co-mingling of funds, which could contaminate Islamic deposits or financing, or indeed both. Rather than being distracted by negativities, the response of Maybank has been to appoint a very credible shari’ah board chaired by Dr. Ahcene Lahsasna, which focuses on managing shari’ah risk in the Islamic subsidiary. Credit, liquidity, and operational risk are the responsibility of the Risk Management Committee of the entire group, who are in turn responsible to the Board of Directors. Part of Malaysia’s responsibility as a global Islamic banking hub is to host the Islamic Financial Services Board (IFSB) that provides advice to central banks concerning the regulation of Islamic banks within their jurisdictions. The recommendations and standards issued by the IFSB are not mandatory, but the aim of the organisation is to identify best practice and facilitate its dissemination in both Muslim majority and Muslim minority countries. It has produced valuable publications on risk management, which are cited on its website, and in 2019, the Board issued a paper on risk sharing.39 Much of the innovative thinking and academic scholarship in Islamic banking and finance has been in Pakistan where the State Bank has made considerable efforts to promote shari’ah-compliant finance. As regulator, the State Bank has published risk-management guidelines for Islamic banking institutions that are consistent with the IFSB guiding principles. Although a late comer to Islamic finance, Pakistan is catching up with the Gulf States and Malaysia, especially since the Meezan Bank took off. Although it only commenced operations in 2002, by 2020 it had 750 branches across Pakistan and a paid-up capital of rupees 12.8 billion as a public listed

48

S H A R I NG A N D M A NAGI NG R I SK I N I SF

company. It provides detailed financial reports, both annually and every six months, which could be useful for academic and professional analysts examining its risk profile. Dr. Muhammad Ashraf Usmani, the Head of Product Development and Shari’ah Compliance at the bank, has authored a useful paper on risk-management issues available on the website.40

4.10 Conclusion Risk sharing is commendable in principle and is widely regarded as a key factor distinguishing Islamic financial institutions from their conventional counterparts. Participation in financial risks provides a legitimate justification for remuneration and a reward for providing a public service. Uncertainty about future financing is unavoidable, but those who have invested in anticipation of positive returns deserve recognition as contributing to the public good, not least if unavoidable events result in losses, as they are committed to burden sharing, which helps others avoid excessive hardship. Islamic financial partnership contracts, notably mudarabah and musharakah, ensure risks are shared in a manner that is not only accepted from a shari’ah perspective, but is also equitable and just. There is no virtue in seeking risk for its own sake, however, or in taking on excessive risk through speculation or gambling, both of which are condemned under shari’ah. Deliberately magnifying risk through market churning and monopolistic exploitation is unacceptable and represents anti-social behaviour. Careful risk management can avoid such outcomes whether undertaken at the institutional level by Islamic banks or at the government level through the regulatory authorities. Despite the merits of risk sharing, important questions remain, notably who shares the risk, and whether the beneficiaries are worthy. In practice, in Islamic banks, the investment mudarabah depositors share the risk and the shareholders benefit from risk reduction. However, shareholders are usually more affluent than bank depositors, and the sharing of risk may therefore be regressive rather than progressive from the perspective of income or wealth distribution. There is also the issue of what depositors should be exposed to macroeconomic risk, which is risks can meaningfully be shared. Should depositors be liable for credit or default risk where Islamic banks have been incompetent in its financial decision-making and have failed to vet properly those seeking finance? Sharing in liquidity risk could be regarded as dubious as Islamic banks and their regulators bear responsibility for this, and not bank depositors. Similarly, should investment depositors be exposed to operational risk when information technology systems fail due to negligence by Islamic banks or underinvestment in firewalls to protect clients’ account data? It is also problematic if banks are primarily the responsibility of governments

49

RODN E Y W I L S ON

and regulatory authorities, or for shari’ah risk, which should be the responsibility of shari’ah board members qualified in fiqh. Overall, while not wanting in any way to criticise the significance of risk sharing, it is evident that the subject requires further investigation and debate amongst those involved in Islamic finance, including the academic community. Risk is multidimensional and evident at different levels, which comes back to the question of who should share risk and the recognition of different types of risk.

Notes 1 Askari, Hossein, Zamir Iqbal, Noureddine Krichene, and Abbas Mirakhor. (2012). Risk Sharing in Finance: The Islamic Finance Alternative. Hoboken, NJ: John Wiley. 2 Weiss, Dieter. “Ibn Khaldun on economic transformation.” International Journal of Middle East Studies 27.1 (1995): 29–37. 3 Altman, Edward I. and Anthony Saunders. “Credit risk measurement: developments over the last 20 years.” Journal of Banking and Finance 21.11–12 (1997): 1721–1742. 4 Duclos, Rod, Echo Wen Wan, and Yuwei Jiang. “Show me the honey! Effects of social exclusion on financial risk-taking.” Journal of Consumer Research 40.1 (2012): 122–135. 5 Duffie, Darrell and Kenneth J. Singleton. (2012). Credit Risk Pricing, Measurement, and Management. Princeton, NJ: Princeton University Press. 6 Waemustafa, Waeibrorheem and Suriani Sukri. “Bank specific and macroeconomics dynamic determinants of credit risk in Islamic banks and conventional banks.” International Journal of Economics and Financial Issues 5.2 (2015): 476–481. 7 Kahf, Monzer. “Islamic banks at the threshold of the third millennium.” Thunderbird International Business Review 41.4–5 (1999): 445–460. 8 Iqbal, Zamir and Bushra Shafiq. “Islamic finance and the role of Qard-alHassan (Benevolent Loans) in enhancing inclusion: a case study of AKHUWAT.” ACRN Oxford Journal of Finance and Risk Perspectives 4.4 (2015): 23–40. 9 Siddiqui, Anjum. “Financial contracts, risk and performance of Islamic banking.” Managerial Finance 34.10 (2008): 680–694. 10 Ito, Sanae. “Microfinance and social capital: does social capital help create good practice?” Development in Practice 13.4 (2003): 322–332. 11 Dusuki, Asyraf Wajdi. “Empowering Islamic microfinance: lesson from groupbased lending scheme and Ibn Khaldun’s concept of ‘Asabiyah.’” Fourth International Islamic Banking and Finance Conference, Monash University Kuala Lumpur, 2006. 12 Ismal, Rifki. “Assessment of liquidity management in Islamic banking industry.” International Journal of Islamic and Middle Eastern Finance and Management 3.2 (2010): 147–167. 13 Akhtar, Muhammad Farhan, Khizer Ali, and Shama Sadaqat. “Liquidity risk management: a comparative study between conventional and Islamic banks of Pakistan.” Interdisciplinary Journal of Research in Business 1.1 (2011): 35–44. 14 Yulianto, Agung and Badingatus Solikhah. “The internal factors of Indonesian Shari’ah banking to predict the mudharabah deposits.” Review of Integrative Business and Economics Research 5.1 (2016): 210.

50

S H A R I NG A N D M A NAGI NG R I SK I N I SF

15 Hartlage, Andrew W. “The Basel III liquidity coverage ratio and financial stability.” Michigan Law Review 111 (2012): 453. 16 Abdul-Rahman, Yahia. “Islamic instruments for managing liquidity.” International Journal of Islamic Financial Services 1.1 (1999): 1–7. 17 Ismath Bacha, Obiyathulla. “The Islamic inter-bank money market and a dual banking system: the Malaysian experience.” International Journal of Islamic and Middle Eastern Finance and Management 1.3 (2008): 210–226. 18 Belás, Jaroslav, et  al. “Electronic banking security and customer satisfaction in commercial banks.” Journal of Security and Sustainability Issues 5.3 (2016): 411–422. 19 Scandizzo, Sergio. “Risk mapping and key risk indicators in operational risk management.” Economic Notes 34.2 (2005): 231–256. 20 Mohammed Sarea, Adel and Mustafa Mohd Hanefah. “The need of accounting standards for Islamic financial institutions: evidence from AAOIFI.” Journal of Islamic Accounting and Business Research 4.1 (2013): 64–76. 21 Hoq, Mohammad Ziaul, Nigar Sultana, and Muslim Amin. “The effect of trust, customer satisfaction and image on customers’ loyalty in the Islamic banking sector.” South Asian Journal of Management 17.1 (2010): 70–93. 22 Waemustafa, Waeibrorheem and Suriani Sukri. “Bank specific and macroeconomics dynamic determinants of credit risk in Islamic banks and conventional banks.” International Journal of Economics and Financial Issues 5.2 (2015): 476–481. 23 Imam, Patrick and Kangni Kpodar. “Islamic banking: how has it expanded?” Emerging Markets Finance and Trade 49.6 (2013): 112–137. 24 Čihák, Martin and Heiko Hesse. “Islamic banks and financial stability: an empirical analysis.” Journal of Financial Services Research 38.2–3 (2010): 95–113. 25 Smolarski, Jan, Michael Schapek, and Mohammad Iqbal Tahir. “Permissibility and use of options for hedging purposes in Islamic finance.” Thunderbird International Business Review 48.3 (2006): 425–443. 26 Dusuki, Asyraf Wajdi. “Shariah parameters on Islamic foreign exchange swap as hedging mechanism in Islamic finance.” ISRA International Journal of Islamic Finance 1.1 (2009): 77–99. 27 Shafii, Z., A. Z. Abidin, S. Salleh, K. Jusoff, and N. Kasim. “Post implementation of Shari’ah governance framework: the impact of Shari’ah audit function towards the role of Shari’ah committee.” Middle East Journal of Scientific Research 13(SPLISSUE) (2013): 7–11. 28 Waemustafa, Waeibrorheem and Azrul Abdullah. “Mode of Islamic bank financing: does effectiveness of Shari’ah supervisory board matter?” Australian Journal of Basic and Applied Science 9.37 (2015): 458–464. 29 Ercanbrack, Jonathan. “The regulation of Islamic finance in the United Kingdom.” Ecclesiastical Law Journal 13.1 (2011): 69–77. 30 Djojosugito, Reza. “Mitigating legal risk in Islamic banking operations.” Humanomics 24.2 (2008): 110–121. 31 Hanif, Muhammad. “Differences and similarities in Islamic and conventional banking.” International Journal of Business and Social Sciences 2.2 (2014): 1–25. 32 Shariff, Ros Aniza Mohd and Abdul Rahim Abdul Rahman. “An exploratory study of Ijarah accounting practices in Malaysian financial institutions.” International Journal of Islamic Financial Services 5.3 (2003): 1–15. 33 Metwally, Mokhtar M. “Differences between the financial characteristics of interest-free banks and conventional banks.” European Business Review 97.2 (1997): 92–98. 34 Osmani, Noor Mohammad and Md Faruk Abdullah. “Musharakah mutanaqisah home financing: a review of literatures and practices of Islamic banks in Malaysia.” International Review of Business Research Papers 6.2 (2010): 272–282.

51

RODN E Y W I L S ON

35 Sundararajan, Venkataraman. “Risk measurement and disclosure in Islamic finance and the implications of profit sharing investment accounts.” Islamic Economics and Finance 1 (2007): 121–152. 36 Archer, Simon and Rifaat Ahmed Abdel Karim. “On capital structure, risk sharing and capital adequacy in Islamic banks.” International Journal of Theoretical and Applied Finance 9.03 (2006): 269–280. 37 Ginena, Karim. “Sharī ‘ah risk and corporate governance of Islamic banks.” Corporate Governance 14.1 (2014): 86–103. 38 Alzalabani, Abdulmonem and Reji D. Nair. “Financial recession, credit crunch and Islamic banks: a case study of Al Rajhi Bank in the Kingdom of Saudi Arabia.” East West Journal of Economics and Business 16.1 (2013): 15–36. 39 Islamic Financial Services Board, Risk Sharing in Islamic Banking, Working Paper: 10/05/2019, Kuala Lumpur. 40 Usmani, Muhammad Imran Ashraf. (2020). Examining the Prudence of Islamic Banks: A Risk Management Perspective. Karachi: Meezan Bank.

References Abdulmonem Alzalabani and Reji D. Nair. “Financial recession, credit crunch and Islamic banks: a case study of Al Rajhi Bank in the Kingdom of Saudi Arabia.” East West Journal of Economics and Business 16.1 (2013): 15–36. Abdul-Rahman, Yahia. “Islamic instruments for managing liquidity.” International Journal of Islamic Financial Services1.1 (1999): 1–7. Akhtar, Muhammad Farhan, Khizer Ali, and Shama Sadaqat. “Liquidity risk management: a comparative study between conventional and Islamic banks of Pakistan.” Interdisciplinary Journal of Research in Business 1.1 (2011): 35–44. Altman, Edward I. and Anthony Saunders. “Credit risk measurement: developments over the last 20 years.” Journal of Banking and Finance 21.11–12 (1997): 1721–1742. Archer, Simon and Rifaat Ahmed Abdel Karim. “On capital structure, risk sharing and capital adequacy in Islamic banks.” International Journal of Theoretical and Applied Finance 9.03 (2006): 269–280. Askari, Hossein, Zamir Iqbal, Noureddine Krichene, and Abbas Mirakhor. (2012). Risk Sharing in Finance: The Islamic Finance Alternative. Hoboken, NJ: John Wiley. Belás, Jaroslav, et al. “Electronic banking security and customer satisfaction in commercial banks.” Journal of Security and Sustainability Issues 5:3 (2016): 411–422. Čihák, Martin and Heiko Hesse. “Islamic banks and financial stability: an empirical analysis.” Journal of Financial Services Research 38.2–3 (2010): 95–113. Djojosugito, Reza. “Mitigating legal risk in Islamic banking operations.” Humanomics 24.2 (2008): 110–121. Duclos, Rod, Echo Wen Wan, and Yuwei Jiang. “Show me the honey! Effects of social exclusion on financial risk-taking.” Journal of Consumer Research 40.1 (2012): 122–135. Duffie, Darrell and Kenneth J. Singleton. (2012). Credit Risk Pricing, Measurement, and Management. Princeton, NJ: Princeton University Press. Dusuki, Asyraf Wajdi. “Empowering Islamic microfinance: lesson from groupbased lending scheme and Ibn Khaldun’s concept of ‘Asabiyah.’” Fourth International Islamic Banking and Finance Conference, Monash University Kuala Lumpur, 2006.

52

S H A R I NG A N D M A NAGI NG R I SK I N I SF

Dusuki, Asyraf Wajdi. “Shariah parameters on Islamic foreign exchange swap as hedging mechanism in Islamic finance.” ISRA International Journal of Islamic Finance 1.1 (2009): 77–99. Ercanbrack, Jonathan. “The regulation of Islamic finance in the United Kingdom.” Ecclesiastical Law Journal 13.1 (2011): 69–77. Ginena, Karim. “Sharī ‘ah risk and corporate governance of Islamic banks.” Corporate Governance 14.1 (2014): 86–103. Hanif, Muhammad. “Differences and similarities in Islamic and conventional banking.” International Journal of Business and Social Sciences 2.2 (2014): 1–25. Hartlage, Andrew W. “The Basel III liquidity coverage ratio and financial stability.” Michigan Law Review 111 (2012): 453. Hoq, Mohammad Ziaul, Nigar Sultana, and Muslim Amin. “The effect of trust, customer satisfaction and image on customers’ loyalty in the Islamic banking sector.” South Asian Journal of Management 17.1 (2010): 70–93. Imam, Patrick and Kangni Kpodar. “Islamic banking: how has it expanded?” Emerging Markets Finance and Trade 49.6 (2013): 112–137. Iqbal, Zamir and Bushra Shafiq. “Islamic finance and the role of Qard-al-Hassan (Benevolent Loans) in enhancing inclusion: a case study of AKHUWAT.” ACRN Oxford Journal of Finance and Risk Perspectives 4.4 (2015): 23–40. Islamic Financial Services Board. Risk Sharing in Islamic Banking, Working Paper: 10/05/2019, Kuala Lumpur. Ismal, Rifki. “Assessment of liquidity management in Islamic banking industry.” International Journal of Islamic and Middle Eastern Finance and Management 3.2 (2010): 147–167. Ismath Bacha, Obiyathulla. “The Islamic inter-bank money market and a dual banking system: the Malaysian experience.” International Journal of Islamic and Middle Eastern Finance and Management 1.3 (2008): 210–226. Ito, Sanae. “Microfinance and social capital: does social capital help create good practice?” Development in Practice 13.4 (2003): 322–332. Kahf, Monzer. “Islamic banks at the threshold of the third millennium.” Thunderbird International Business Review 41.4–5 (1999): 445–460. Metwally, Mokhtar M. “Differences between the financial characteristics of interestfree banks and conventional banks.” European Business Review 97.2 (1997): 92–98. Mohammed Sarea, Adel and Mustafa Mohd Hanefah. “The need of accounting standards for Islamic financial institutions: evidence from AAOIFI.” Journal of Islamic Accounting and Business Research 4.1 (2013): 64–76. Osmani, Noor Mohammad and Md Faruk Abdullah. “Musharakah mutanaqisah home financing: a review of literatures and practices of Islamic banks in Malaysia.” International Review of Business Research Papers 6.2 (2010): 272–282. Scandizzo, Sergio. “Risk mapping and key risk indicators in operational risk management.” Economic Notes 34.2 (2005): 231–256. Shafii, Z., A. Z. Abidin, S. Salleh, K. Jusoff, and N. Kasim. (2013). “Post implementation of Shari’ah governance framework: the impact of Shari’ah audit function towards the role of Shari’ah committee.” Middle East Journal of Scientific Research 13(SPLISSUE): 7–11. Shariff, Ros Aniza Mohd and Abdul Rahim Abdul Rahman. “An exploratory study of Ijarah accounting practices in Malaysian financial institutions.” International Journal of Islamic Financial Services 5.3 (2003): 1–15.

53

R odney W ilson

Siddiqui, Anjum. “Financial contracts, risk and performance of Islamic banking.” Managerial Finance 34.10 (2008): 680–694. Smolarski, Jan, Michael Schapek, and Mohammad Iqbal Tahir. “Permissibility and use of options for hedging purposes in Islamic finance.” Thunderbird International Business Review 48.3 (2006): 425–443. Sundararajan, Venkataraman. “Risk measurement and disclosure in Islamic finance and the implications of profit sharing investment accounts.” Islamic Economics and Finance 1 (2007): 121–152. Usmani, Muhammad Imran Ashraf. (2020). Examining the Prudence of Islamic Banks: A Risk Management Perspective. Karachi: Meezan Bank. Waemustafa, Waeibrorheem and Azrul Abdullah. “Mode of Islamic bank financing: does effectiveness of Shari’ah supervisory board matter?” Australian Journal of Basic and Applied Science 9.37 (2015): 458–464. Waemustafa, Waeibrorheem and Suriani Sukri. “Bank specific and macroeconomics dynamic determinants of credit risk in Islamic banks and conventional banks.” International Journal of Economics and Financial Issues 5.2 (2015): 476–481. Weiss, Dieter. “Ibn Khaldun on economic transformation.” International Journal of Middle East Studies 27.1 (1995): 29–37. Yulianto, Agung and Badingatus Solikhah. “The internal factors of Indonesian Shari’ah banking to predict the mudharabah deposits.” Review of Integrative Business and Economics Research 5.1 (2016): 210.

54

5 DEBT, RISK, AND ISLAMIC MORAL ECONOMY Toseef Azid, Osamah H. Al Rawashdeh, and Muhammad Omer Chaudhry 5.1 Introduction Islamic moral economic system is based on justice, ihsan, and silah-i-rahm; it creates an environment in which everyone cares for each other. According to Islamic teachings, all Muslims are brothers and Muslim Ummah is like one all-encompassing body. If one part of the body feels pain, the whole body feels it. The same rule can be applied in the debt market. However, in this chapter, we consider only household debt and not national debt. Allah (swt) guides the Muslim Ummah about the process of debt exchange, risk, and the moral obligations. According to the teachings of the Qur’an and Sunnah, debt and risk cannot be forbidden and cannot be considered as vices in Islamic society. However, Islam has given its own rules and regulations that create an environment of brotherhood. According to the teachings of Islam, risk is not a vice in the debt market; however, it should be in accordance with the model prescribed by Islamic jurisprudence. In Islamic moral environment, one can observe the relationship between the creditor and debtor. Islam guides its followers on how debt-based transactions can work in this environment and the role of shari’ah-compliant products. It is also permitted that a Muslim can enter the secular debt market but must follow the restrictions imposed by Islamic jurisprudence. The real objective is to ensure the economic system flourishes and to increase the economic activities for the welfare of the whole community and society. However, simultaneously, the aim is also to fight against greed, deception, corruption, cheating, and dishonesty. Ultimately, it will stabilize the debt market. All products of the Islamic debt market are asset based. There is no room for interest and usury. However, debt exchange is allowed, and philanthropy is encouraged in the process of debt exchange. Those products that are harmful to society are not allowed. Keeping in line with the above aims, we organized this study in the following way: After introduction, the discussion on credit and debt is presented; DOI: 10.4324/9781003050209-5

55

TOSEEF AZID ET AL.

in this section, the theoretical background about debt is presented: How is greed involved in debt transactions? How can one be respected by lenders and borrowers? This section will also elaborate the different cases in which debt and its instruments are harmful to society and instances where these will work for the protection and construction of the Islamic community and how debt and other financial instruments are supportive of a healthy Islamic society. If a loan is broken or stressed, how do Islamic teachings guide us and what are the solutions? What are the teachings of Islam about the savings and borrowings? And at the end, how do teachings of the Qur’an and practices of the Prophet (saw) guide us about the construction of a moral economy. Section 5.2 elaborates the relationship between risk and debt in Islamic moral economy and also discusses how risk is involved in financial instruments (debt and joint ventures). At the end, conclusion and suggestions are presented.

5.2 Discussion on credit and debt in conventional literature At present, a number of households play a significant role in the debt market, i.e. either as lenders or borrowers. In economics textbooks, these lenders are considered as savers. It is also a well-known phenomenon that risk always exists in the debt market because nobody is able to predict future activities, i.e. the future is always undetermined. The world of economics has seen a number of defaults in loans, leading to debt crises.1 In the previous two decades, these were known as Minsky moments.2 Generally, the foundations of the conventional debt market are value neutral. Although currently a number of organizations work for the welfare of humanity through different programs by providing education, health services, social services, housing, and many others, unfortunately, no organization works for the improvement of the debt market or tunes it towards virtues. However, the teachings of the different religions, especially the Abrahamic religions guide their followers that in normal circumstances, they should not involve in interest-based transactions of debt. However, Malinowski (1922), Mauss (1990), and Polanyi (1944) were not comfortable with the natural classical or neo-classical economy, whereas they are in the favor of the economy of gifts or exchange. Apparently, current literature distinguishes debt from credit. Generally, in this literature, it is assumed that credit is of virtue, credibility, honor, repute, and trustworthiness (Gregory, 2012; Nugent, 1996; Truitt, 2007; Zelizer, 1994), whereas debt seems to be a vice (Howe, 1998; Lowrey, 2006; Taussig, 1987). In most cases, creditors are considered creative, dominant, superior, and powerful and also known as importunate, whereas debtors are considered weak, damaging, fragile, and inferior and are known as impecunious. Gregory (2012) wonders why credit is assumed as good and virtuous and debt is considered bad and vicious, and similarly a creditor is considered virtuous and a debtor is considered vicious. He also reviews 56

D E B T, R I S K , A N D I S L A M I C M O R A L E C O N O M Y

different religions and concludes that in every religion debt is considered a vice and credit, a virtue. However, in his opinion, both are equal because in ‘bookkeeping 201’ every debt is equal to credit. Credit and debt in real terms are attached to each other and are both sides of the same coin. On the other hand, Gudeman (2001) indicated that both debtor and creditor have different positions in the community, i.e. the creditor has a higher status than the borrower. Although Mauss (1990) opined that credit and debt make a pyramid where credit is positioned on the top and debt is at a lower level, in his opinion, this exchange is the sign of the unity of the community. However, Malinowski (1922) said that whatever the situation, the giver has more power and control than the receiver. In contrast, Gregory (2012) stated that “An individual should have credit prior to obtaining a debt”. He divided the lending process into three stages: i.e. preliminary, the liminal, and the postliminary. He further added that credit has the ability to change its shape, and it is a request from a person that is related to the future and “exists as a potentiality”. On the other hand, if the requestor’s credit scoring is good risk for the creditor, then loan is sanctioned or granted, and thereby credit is transformed into debt. If a loan is not granted, then it is known as potential credit, and if granted, it will be converted into actual credit. It is the general psychology of the borrower who is eager to receive money but not always ready to pay back. In some cases, receiving debt is fun for borrowers, but in any case, they do not enjoy paying back. It is also interesting to note that in most cases, when money lending is good, it is named credit, and if vice versa, it is named debt: For example, a loan from Grameen bank is known as micro-credit instead of micro-debt. According to Heinemann (2010), micro-debt is the other side of micro-credit. Lee and David (2010) present the sad story of microfinance in India, where in the case of default, either sexual harassment follows or debtors commit suicide. Malinowski (1922) discussed positive reciprocity (if someone is humble with a debtor) and negative reciprocity (if harsh with a debtor) of the debt. Trautmann (1981) and Ranajit Guha (1985) used this term as religious reciprocity, i.e. giving and receiving is based on the merit of religion. According to Dunn (2004), the same economic resources are considered as credit in the hands of one group and on the other side, those are considered debt in the hands of others. The term credit is the exchange of resources when the lender is not assured that he or she will receive the repayment. It is generally assumed that a creditor gives up his or her present utilities for the expected future. Credit is also known as fictitious capital. According to Anderlini and Sabourian (1992, pp. 75–106), it is a game of speculations; however, it is the opposite for the creditor and the debtor, i.e. a borrower speculates about a future receipt of resources, and on that basis, he or she transforms them into real resources, whereas a creditor prevents oneself from not using these resources and speculates that in future, he or 57

TOSEEF AZID ET AL.

she will realize them. Generally, it is also assumed that debt is not a symbol of growth as the credit is under the risk of non-payment. However, some scholars support the debt process and argue that debt is productive (Roitman, 2005). It is also argued in the literature that debt is not always toward fulfilling needs; on the contrary, the needs generate new debts, i.e. you “buy beyond your needs”. Mauss (1954) and Minsky (1993) said that this exchange is based on reciprocity; L’evi-Strauss (1949) and Sahlins (1972) believed it is a restricted exchange, whereas Sneath (2006) said that this phenomenon helps the members of a society interact. There is a clear-cut difference between gifts and commodities, i.e. gifts are based on the qualitative personal relations and their contracts are invisible and hidden, whereas commodities are based on the quantitative relationships and their contracts are visible (Alexander, 2001). Debt may have a different structure, for example, Battaglia (1992) discussed about intergenerational debt and Verdery (2003) explained collective debt, especially in developing economies. In the literature, we find long discussions about the behavior of both borrowers and creditors: Some say that debtor is a thief, and on the other side, it is considered victimizing; some say that creditor is a miser and others opine that creditor is a benefactor; it is also said not known how one can protect the debt market from moral hazards and asymmetric information. It is also observed in different societies that creditor is assumed as wicked and evil. However, in many places, debt is considered as a blessing rather than a trap. In reality, borrowers fulfill their needs, and as investors, they invest these funds to improve their business growth. They have the ability to serve the community, create products for society, and improve the rate of employment. However, it is also observed that in most cases, if lenders are unwilling to invest these funds, it is because borrowers cannot pay back. MacDonald (2000) said that if a creditor is aware that he or she will not likely receive the lending amount, then he or she creates a different type of social relationship, which is not good for a healthy society. Marilyn Strathern (1975) expressed that there is no hard and fast rule about the process of lending among family members. In this context, there is a similarity between gift exchange and the obligation to give. Generally, small loans are informal ones (if one asks for a large amount, it will be refused), but if a big amount is required, then the debtor has to approach formal institutions. However, in most communities, compassionate loans cannot be refused, e.g. for funerals, marriages, and health-related issues. However, repayment traditions are dependent on the traditions of the society: In some societies, people return immediately (on the date of maturity) and in some societies, delayed return is the general norm (Woodburn, 1982). However, in most societies, interest on debt is assumed as a social institution and due to the presence of interest, exchange takes place between debtor and creditor. Maurer (2006) in his new book entitled “Pious Property: Islamic Mortgages in the United States” discussed the history of mortgage 58

D E B T, R I S K , A N D I S L A M I C M O R A L E C O N O M Y

and expressed that interest plays its role as a social institution. However, he further elaborated that if there is no interest, even then the debt/credit process becomes a significant “socially binding force”. Kwon (2007) discussed ghost money and cosmic debt; he discovered that in different societies, traditions are different; in some societies, especially according to the belief of Chinese and Vietnam’s cultures, “every birth to this world was based on the allowance of a loan from ‘the Treasury of the Other world,’ or ‘the Bank of Hell’” (p. 77). Sahlins (1972) discussed morality, exchange, and spatiality in the context of credit and debt relations. He also discussed free gifts, seizure, and all things in between. It is worthwhile to note that credit/debt is not only limited to small communities; it can be extended worldwide (Stiansen & Guyer, 1999; Thomas, 1991; van Binsbergen & Geschiere, 2005). Pietz (1997), Chu (2010), and many others discussed debt defaulters and bodily punishment and debt slavery (bonded labor).3 Currently in the debt market, credit scoring has become an important tool for measuring the creditworthiness of borrowers. As discussed by Leyshon and Thrift (1999), on the basis of this credit scoring, credit agency/financial institutions categorize borrowers as prone to bad or good risk. It is worthwhile to note that during the past few decades, sub-prime lending was extensively used by banks and they charged a high interest rate from sub-prime borrowers, and we have seen a tremendous growth of banksters in the banking industry during the past three decades. (Gregory, 2012). However, bad debt is a term that is related to negative interest. However, borrowers have the right to request, and creditors have the right to refuse or grant based on the certain cultural norms. Sharp (2000) reviewed the literature about commoditization of the parts of the human body; Sharp said if exchange of body parts is given as a gift, then it is considered as a moral action; however, it is much criticized in the literature because hidden commerce is involved in this exchange. Brantlinger (1996) and Song (2009) discussed public credit and opined that the reputation of nations is related to effective national debt payments. According to Papataxiarchis (1999), most of the developing countries have become extravagant due to public debt. In this respect, Papataxiarchis considered the case of the economy of Greece. Peebles (2010) concluded that the credit– debt nexus made very strong social ties among members of a community with a range of relationships varying from loyalty to antagonism, enmity to friendship, conflict to harmony, etc. In some cases, the relationship is normative, moral, kind, honorable, benevolent, or the reverse exists among the creditor and debtor. However, he further added that the economic effects of the nexus of credit and debit cannot be separated from its moral values. However, Gregory (2012) distinguished between family loans and institutional loans: Credit and debt move side by side with a positive rate of interest in institutional loans, whereas the interest rate may be positive, zero, or negative in family loans, which is virtuous (if zero or negative); whereas 59

TOSEEF AZID ET AL.

for others, it may be a low interest rate or vicious high interest rate. Nelson (1969) says interest is the nucleus of the process of credit, whereas the growth of commerce is based on the supply of credit. However, the structure of debt and credit is different in family loans. It is also worthwhile to note that for users of credit cards, credit is the amount that is still not used, whereas debt is the amount that has been used by the card holder and still not paid, where both credit/debit are not moving parallel to each other.

5.3 Debt in the Islamic moral economy4 It is a well-known practice in the conventional debt market that debt relationships are generally based on greed. The most omniscient reason is that most of the times, the debtor overestimates his ability to repay, which is not usually realized or a factor of lie exists in relationships. When it is realized that a debt cannot be repaid, the debtor and creditor become greedy and insincere, and they start to deal beyond justice and love. Allah (swt) has created everything in this world, including debt and credit. The purpose of debt and credit is to promote love and kindness among members of the society. Through borrowing and lending, protection and construction exist in the society and community. It is also worthwhile to note that if the debtor is not able to fulfill his promise, then it does not always mean that the debtor is a liar or committing sins. According to Gregersen (2003),5 trust among members of a society requires risk, so risk is not vicious, but it is a virtuous circle between trust and risk willingness. If due to certain reasons a debtor is not able to pay, in one way, it improves the state of love and kindness (Drunen, 2015). In most cases, debt is not considered vicious; in fact, it is virtuous; it fulfills the needs of the debtor: The creditor can give his savings to the debtor for a limited time; therefore, in this way, the love and affection of both the parties will improve. However, risk is involved in the process of lending–borrowing; however, it is advised that borrowers should not borrow beyond their repayment capacity and not be too involved in buying expensive commodities on debt, for example, a car, house, and many such commodities (Durrenberger & Palsson, 2015). Durrenberger and Palsson (2015) stated that we should move from capitalism to virtualism. It is assumed in the literature that debt, guilt, and sin are one and the same thing. Debt is not sacred; however, forgiveness of debt is considered as sacred.6 Next we will discuss the state of credit, debt, debtor, and creditor in light of the Qur’an and sunnah. The word qard [debt] is from the root qaf-ra-daad, which means to cut or save something. When we give a loan to someone, we are cutting some of our resources or savings and giving it to other people. It is worthwhile to note that the longest verse of the Qur’an is known as verse of debt (Qard) (Chapter Al Baqrah, Verse 2827). Lending money is an acceptable action in Islam. It is mandatory if any other Muslim brother is in dire need, it is 60

D E B T, R I S K , A N D I S L A M I C M O R A L E C O N O M Y

the duty of other Muslim brothers, those with sufficient resources to lend their money to the needy brother; however, lending on interest is not permitted. However, it is a contract that must be witnessed by two persons, or it should be guaranteed through some collateral. Even in this case, it is recommended to have a written agreement. It is necessary to write and testify. According to the hadith of the Prophet (pbuh), there are three kinds of people whose supplication Allah (swt) would not answer. And among them is a man who lent some money to other person and did not have witnesses to testify or to witness what he had done. And the other aspect is giving money to foolish people. As Allah (swt) ordered “Do not give your money to the foolish.” However, lending is much appreciated in the Islamic system, but the constraint is that it should be for the sake of Allah (swt) with good intentions. However, this should be benevolence, without any extra benefit, but in the eyes of Allah (swt), this is a kind of investment and its return on investment is immeasurable. According to one Hadith of the Prophet (saw), if someone gives charity, it has one-fold reward, but if someone lends money to other Muslim brothers, then the reward is two-fold. In real terms, giving loan to other Muslim brothers is considered as charity. The Prophet (saw) says if a debtor is unable to pay back on the date of maturity and the creditor gives him some time and postpones the collection, then Allah (swt) will give him reward as charity (double the amount) for each and every day until the debtor has paid back the money.8 On the other hand, the debtor should be a trustworthy and needy brother must have a strong will to pay back. According to another saying of the Prophet (saw), on the day of judgment, Allah (swt) will give a lot of money to one man whereas he has not too many prayers in his account but the only action he had done was to postpone the payment of debt indefinitely.9 Then Allah (swt) is likely to say that you are more merciful than anyone, so I forgive you and give you a place in paradise.10 Allah (swt) says, in the Qur’an, “And if the debtor is in hard time, if he does not have money then grant him time till it is easy for him to repay.” Allah also says that it is better for the creditor to forgive the debtor if he cannot pay.11 However, sometimes it is difficult for the creditor to become soft if there is a series of broken promises from the end of the debtor, which has a negative impact on the personality of the creditor, which unfortunately makes him harsh, rough, and tough. The great scholar Abu Hanifa lent money to his neighbor and he was afraid to sit in the shade of his neighbor’s wall, because it could be considered as interest. The Prophet (saw) said that one ought not to involve in any transaction of debt that has an extra amount in the contract; this is sin and even when someone is needy and borrows money on the basis of interest, he commits a sin as the creditor commits a sin because of receiving the extra amount. However, in gratitude, if a debtor pays something extra without any pressure from the creditor, it is permitted.12 Debt repayment is taken very seriously in the Islamic system. Prophet (saw) said that if a person has to be martyred three times and he 61

TOSEEF AZID ET AL.

could not pay his debt, then he will not be allowed to enter paradise. Otherwise, there is a big reward for the martyred.13 Or if someone dies, it is a must to pay his debt before the distribution of his assets among the legal heirs.14 If anyone borrows money even from a non-Muslim and his intention is not to pay back, the Prophet had this to be (saw) said: “Whoever borrows an amount of money, with an ill intent, not to pay it back; he will meet Allah on the day of Judgment, as a thief, as a robber.” The frequent supplication of the Prophet (saw) was to seek refuge from the hardship of debt.15 It is also assumed that debt is humiliation during the day, and it is a cause for worry at night. The Prophet (saw) said that if anyone is free from arrogance, ghulool (public money), and debt, that person will go to paradise. However, debt can be transferred from a poor debtor to a rich person who can take the responsibility to pay it back.16 Why a debtor will not enter paradise and why it is considered a vice is justified by Ibn Abd Al Barr, in this way: If a debtor is able to pay back the debt and does not pay, or he borrows but he does not need it, or he borrows with this intent that he will not pay it back or he knows that his financial position is not so strong, thus, he will not be able to pay it back, and also, when someone is not able to pay back, he is breaking his promises and becoming a liar.17 Sheikh ‘Abd al-Hamid Kishk says, A debtor, on the other hand eagers to collect the funds to fulfill his needs but later on becomes lazy when payment time becomes matured, as this gives a lot of strain to him. As it is a well-known phenomenon, Islam disapproves of begging but begging is allowed for someone who is under a heavy debt.18 This is the immoral part of debt. However, it depends upon how well the creditor knows the borrower, how much trust the creditor has on the debtor, and how much risk he is willing to take. However, all money transactions should be interest-free. It is also advisable that if any person who lent money and he has not received it from the debtor, then he should not propagate such behavior as people will not do good deeds. As we have discussed above, lending money is a very appreciable act and has a great reward. The Prophet (saw) also said that if someone is lending money to you, then this is his reward to praise him, i.e. pray for the lender and pay according to the contract. Islamic moral economy discourages borrowing but on the other hand, encourages lending and appreciates fulfilling promises and obligations, which is the moral value of debt, and it is based on the justice, ihsan, and sila-i-rahmi. In technical terms, credit has the same shape in Islamic economy, either there is a preliminary phase, liminal phase, or a postliminary phase. If on the request of borrowers, the creditor grants the loan, he earns a reward, and if he gives more time if the debtor struggles to pay back, then the creditor earns more reward. 62

D E B T, R I S K , A N D I S L A M I C M O R A L E C O N O M Y

5.4 Risk In this life, nothing is completely certain, so decisions are taken in an uncertain environment. Thus, in this real world, it is difficult to draw a line among natural, social, and religious events. Whenever we discuss risk, we have to consider these three dimensions. In a general term, risk is considered as a danger of something, either it is natural or social, but it should be for someone with social connections (Gregersen, 2003). According to Luhmann (1973) that risk is associated with trust, which implies that risk is a virtuous state in between trust and risk willingness, and most decisions have some degree of implicit trust. On the other hand, Algan and Cahuc (2007) expressed that distrust has an adverse impact on the activities of economic and social agents. The word risk is derived from the Italian word, i.e. risco and rischio,19 the Greek word riza,20 and the Arabic word rizq;21 later on, this word has been used in every language, and currently, it is extensively used in the fields of gambling and strategic warfare; however, safety is the counterpart of risk. A number of terminologies are used for the word risk, for example, the words like chance, hazard, fate, hope, expectations, and fortune. However, it is very interesting to note that we incur risk every day. If we avoid and protect ourselves from one risk, then we experience another type of risk. So, a question arises about the safety, which is currently replaced by danger (first order); danger is a potential destruction while risk (second order) is incurred due to the decision taken by someone. Rescher (1983) stated that “running a risk” indicates that we are passive, but “taking a risk” indicates that we are active. In the traditional way, risk is a form not a substance, i.e. risk is something for the person experiencing it. However, in the literature, one can find risk as negative whereas expectations are considered as positive. Moreover, in most of the religions, hope is closely related to expectations. However, hope generates trust among the agents whereas expectations are based on the reasonably controlled incomplete information. Table 5.1 depicts the difference between hope and expectations. It is an astonished phenomenon that risk is usually assumed as negative but risk-taking is valued as positive, i.e. accepting potential losses and on the other hand expecting an overall positive outcome. However, the terms Table 5.1 Hope and Expectations Hope 1 2 3

Expectations

Something different in kind Something new of the same sort Cannot be neutral May be neutral Incalculable and uncontrollable Calculable

Source: Gregersen (2003) and Rahner (1975).

63

TOSEEF AZID ET AL.

risk-taking and carrying a risk have different connotations. In this world we always share risk with other agents of the community, because sometimes we carry the burden of those risks taken by others. However, everyone wants to minimize the risk and try to equate potential damages with potential benefits. Beck (1999) defined a “risk society” as one in which we cannot control the random consequences of those actions we have taken to control the risk. It is difficult or rather impossible to calculate the decisions taken by us or anyone else. Similarly, the outcomes of these decisions and actions are not predictable. However, in this world, risk-taking is associated with earnings and returns. So risk-taking as a behavior is assumed to be a non-zero sum game. It is also assumed that the fruits of risk-taking are always greater than the damages. Gregersen (2003) elaborated the different steps of risk, which are summarized as: Risk = Danger + Venture Risk = (Probability of events)(Size of the benefits and damages) Risk = P(E + I)(S) (where E = external outcomes and I = range of Internal responses) Risk = P(E × I)(S) + Ev (where Ev = evaluation defines the size of potential loses) Risk = P(E × I)(Ev)S

5.5 Risk and debt in Islamic moral economy In this real world, nobody knows about the future. Allah (swt) says in Surah Luqman as follows: Verily, Allah! With Him (Alone) is the knowledge of the Hour, He sends down the rain, and knows that which is in the wombs. No person knows what he will earn tomorrow, and no person knows in what land he will die. Verily, Allah is All-Knower, All-Aware (of things). (31:34) In Islam, the link between the present and future is not only limited to this life, but also integrated with the afterlife. So the preliminary, the liminal, and the postliminary have a different definition in Islam, especially as we do not have any knowledge about the postliminary aspects. It is a well-known factor that risk always prevails in the debt market. It is also admitted that risk is created by Allah (swt) and Allah (swt) likes risk in commercial and financial transactions. Furthermore, risk creates an environment of love, justice, kindness, peace, and strong relations among

64

D E B T, R I S K , A N D I S L A M I C M O R A L E C O N O M Y

members of the community (Drunen, 2015). However, we have no significant theoretical development about dealing with the financial risk. The Islamic rule is the usefulness of the actions. Taking debt for prohibited activities is not allowed. Similarly, debt for those business or activities if they have excessive, unavoidable risk and uncertainty is not appreciated. No interest is needed on debt. In Islamic literature one can see two types of risk, i.e. the first one is associated with those activities that have a positive probability and generate wealth whereas the other is linked with those that use the wealth. According to Al-Suwailem (2002), this is a zero sum game; it means it does not generate additional wealth. The value of the decision is not determined by the degree of risk but it depends on its substance. So, permissible risk in Islam is based on the generation of additional value and creation of wealth; however, excessive risk is not desirable, because if it does not generate value, then it becomes gambling. One can conclude that giving debt is religiously desirable, but if risk of nonpayment is involved, then it is advised not to give debt. Even if someone is not well matured or not in his senses, then do not give them loan because it is a risk and do not involve yourself with bad risk.22 However, if a requestor is needy, then it is the duty of the individuals and community to look after them and do not leave them helpless. However, giving a loan is an obligatory duty of Muslim brothers, but reciprocity does not work similar to that in conventional societies. If any activity entails these three factors, risk is accepted. i Degree of inevitability (separating risk from ownership) ii Importance (possibility of success is greater than failure) iii The degree to which it is intentional (intention to succeed and create value, not a strong possibility of losing) Gharar (danger or unknown quantity) can be explained as: i ii iii iv

May or may not occur Trading of unspecified object Unknown, uncertain, and consequences of contract is unknown Excessive gharar is not acceptable (minor gharar is acceptable)

However, risk must be shared between all the associates by following the principle of “gain against guarantee” (al kharaj bi damane). The essence of the Prophet’s (saw) hadith is that all profit must go to the borrower, so long as he accepts the obligation (daman) to return the borrowed principal amount. The term kharaj in the hadith stands for any kind of income that may accrue to the party in question, and therefore the gist of the hadith, in general, is that incomes are legitimately claimed against appropriate obligations, depending on the transaction in question.

65

TOSEEF AZID ET AL.

Islam propagates mitigating the risk in the debt market so in ayat dain (debt), Allah (swt) explains about the procedure for reducing risk. We believe that in this world, every object is created by Allah (swt) and the same goes for risk and debt. Allocation of resources in an optimal way is an important teaching of Islam. The exchange of credit and debt provides an opportunity to allocate resources in an efficient manner. This process of exchange also helps people fulfill their basic needs. As we have discussed above that the three most important ingredients of Islamic economy are justice, ihsan, and sila-i-rahmi. Justice (to share creation resources) and ihsan (to give money without any extra worldly benefit) are part of this process of exchange. Those who do not have enough money/resources can gain benefit by lending and borrowing. As the state of ihsan creates in this exchange, love among members of the Muslim community will automatically increase; the lender provides his resources for a certain period and the borrower’s intent is to return it according to the contract. This is a kind of relationship created by Allah (swt). And Allah (swt) also created an environment in the debt market that has risk as well as uncertainty; however, Allah (swt) taught us in surah al baqrah or how to mitigate this risk by entering a contract of debt and also taught us to do this very carefully. And one should not borrow beyond one’s capacity. It means one should be a risk averter until and unless he or she does not have a good reason for entering a debt contract. However, it is appreciated if someone is ready to take a business risk and its ultimate impact on society is positive in terms of productivity, provision of goods and services, improvement of the state of employment, etc. This risk may be in the form of musharakah or mudarabah. However, in these joint ventures, the ingredient of justice, ihsan, and sila-i-rahm must be present; otherwise, the form is fine, but we have to observe the substance. Debt-based transactions must be shari’ah-compliant, i.e. they may be asset-based or asset-backed.

5.6 Conclusion Islamic moral policy allows lending resources as a financial support to socially viable causes. It is a pure donation system where money has no price. Hence, borrowed capital cannot be rewarded at a fixed rate of return. It is based on the Prophet’s hadith al-kharaju bi al-daman. Islam cleared this misconception that profit is a return on risk rather than a reward for productivity. Profit-sharing instruments, like musharakah and mudarabah create an environment where both parties have the same information about the market, i.e. uniform condition of information efficiency. Lending is unanimously taken in Islamic schools of jurisprudence as a means of ownership transference. All schools believe that lending is a means of ownership transference. They only differed about the time when ownership is transferred, whether it is transferred immediately by contract of qard-i-hasn like the Malkites, or transferred after delivery like Hanafites, 66

D E B T, R I S K , A N D I S L A M I C M O R A L E C O N O M Y

Hanbalites, and Shafites, with some internal differences within the same school. Lending of money, like the lending of any fungible good, is logically defined in Islamic jurisprudence as a means of ownership transference, subject to the condition of returning an equivalent amount at some future time. From the shari’ah point of view, debt is not fun for the borrowers, it is only permitted when anyone has a severe need for it, especially for necessities. On the other hand, it is instructed to creditors to give time to debtors, if they are able to pay in future and forgive them if they are not able to pay. As the Prophet said, narrated by Hudhaifa (ra) From among the people preceding your generation, there was a man whom the angel of death visited to capture his soul. (So his soul was captured) and he was asked if he had done any good deed. He replied, “I don’t remember any good deed.” He was asked to think it over. He said, “I do not remember, except that I used to trade with the people in the world and I used to give a respite to the rich and forgive the poor (among my debtors). So Allah made him enter Paradise.” (Bukhari, Volume 4, Book 56, 659) It is also suggested that there should be an established institution in Muslim countries patronized by the Islamic state. This institution must train society about the different shari’ah dimensions of debt. In our opinion, Islamic financial institutions are more suitable to perform this duty. This has a double benefit, on the one hand, the community will learn about the fiqh issues related to the debt, and on the other hand, the financial institution will not launch products that are not shari’ah-compliant. Even debt products should be asset-based or asset-backed. Last but not least, it is also a need to conduct research on debt in the current circumstances. This is the pioneer work in this field, and we hope that Muslim scholars will also give their attention to this area of research.

Notes 1 For example, worldwide financial crises of 2007. 2 Minsky (1993). 3 In Pakistan, there are cases of debt slavery (bounded labor) in some of the businesses such as Brick Klin workers. 4 From the teaching of Qur’an and the practices of the Prophet (saw), one can conclude that maintaining the institution of zakat, establishing an interest-free economy, implementation of law of inheritance, production of halal products is known as the Islamic economics. But for the Islamic moral economy we ought to go further and maintain the institution of justice, ihsan, and looking after the relatives and other members of the society, and this will transform the Islamic economy into the Islamic moral economy. 5 Gregersen, N. H. (2003). Risk and Religion: Toward a Theology of Risk Taking, Zygon, 38(2), pp. 355–376.

67

TOSEEF AZID ET AL.

6 What is Debt? – An Interview with Economic Anthropologist David Graeber « naked capitalism. 7 “O you who have believed, when you contract a debt for a specified term, write it down. And let a scribe write [it] between you in justice. Let no scribe refuse to write as Allah has taught him. So let him write and let the one who has the obligation dictate. And let him fear Allah, his Lord, and not leave anything out of it. But if the one who has the obligation is of limited understanding or weak or unable to dictate himself, then let his guardian dictate in justice. And bring to witness two witnesses from among your men. And if there are not two men [available], then a man and two women from those whom you accept as witnesses - so that if one of the women errs, then the other can remind her. And let not the witnesses refuse when they are called upon. And do not be [too] weary to write it, whether it is small or large, for its [specified] term. That is more just in the sight of Allah and stronger as evidence and more likely to prevent doubt between you, except when it is an immediate transaction which you conduct among yourselves. For [then] there is no blame upon you if you do not write it. And take witnesses when you conclude a contract. Let no scribe be harmed or any witness. For if you do so, indeed, it is [grave] disobedience in you. And fear Allah. And Allah teaches you. And Allah is Knowing of all things.” (2:282) 8 It was narrated from Buraidah Al-Aslami that the Prophet (pbuh) said: Whoever gives respite (interval, break) to one in difficulty, he will have (the reward of) an act of charity for each day. Whoever gives him respite after payment becomes due, will have (the reward of) an act of charity equal to (the amount of the loan) for each day. (Sunan Ibn Majah Book 15, Hadith 2511, sunnah.com) 9 The Messenger of Allah said, A man would give loans to the people and he would say to his servant: If the debtor is in hardship you should forgive the debt that perhaps Allah will relieve us. So when he met Allah, then Allah relieved him. (Sahih Bukhari 3293, Sahih Muslim 1562) 10 Abu Huraira reported: The Messenger of Allah, peace and blessings be upon him, said, A man would give loans to the people and he would say to his servant: If the debtor is in hardship you should forgive the debt that perhaps Allah will relieve us. So when he met Allah, then Allah relieved him. (Sahih Bukhari 3293, Sahih Muslim 1562, dailyhadithonline.com) 11 “If the debtor is unable to pay, wait till his time of prosperity better time. If you give up the loan as a charity, it would be better for you, if you only knew.” (2:280) 12 The Prophet would pay more than the due amount while repaying debt. Narrated Jabir ibn Abdullah: “The Prophet (pbuh) owed me a debt and gave me something extra when he paid it.” (Sunan Abi Dawud 3347) 13 Surah Bani Israel La Taqoolu. 14 (Allah (swt) says, “If you have brothers or sisters, your mother receives a sixth, after any bequest you make or any debts.” (4:11) The Prophet (pbuh) said, “The soul of the deceased believer remains pending on account of the debt till it (the debt) is repayed.” (At-Tirmidhi, Book 7, Hadith 49, sunnah.com) 15 Anas ibn Malik said, “The Prophet, may Allah bless him and grant him peace, used to often say, ‘O Allah, I seek refuge with You from worry, sorrow, incapacity,

68

D E B T, R I S K , A N D I S L A M I C M O R A L E C O N O M Y

16 17 18 19 20 21 22

laziness, cowardice, avarice, being overburdened by debt and being overcome by other men.’” (Al-Adab Al-Mufrad 801, sunnah.com) The Prophet (pbuh) said, “Procrastination (delay) in paying debts by a wealthy man is injustice. So, if your debt is transferred from your debtor to a rich debtor, you should agree.” (Sahih al-Bukhari 2287, sunnah.com) Aisha (radiyallahu anha) asked the Prophet why he made so much dua against incurring debts. He replied, “Whoever gets into debt speaks lies, and makes a promise and breaks it.” (Sunan an-Nasa’i 5454, sunnah.com) “Begging is not lawful except for one of three cases: a man who is in heavy debt, so begging is permissible for him until he pays it, after which he must stop….” (Sahih Muslim 1044, dailyhadithonline.com) Danger with venture. Cliff and root. Dependency upon God or fate. To those weak of understanding Make not over your property, which Allah hath made a means of support for you, but feed and clothe them therewith, and speak to them words of kindness and justice (4:5).

References Alexander, C. (2001). Legal and binding: time, change and long-term transactions. Journal of the Royal Anthropological Institute, 7(3), 467–485. Algan, Y. and Cahuc, P. (2007). La société de défiance. Paris: Rue d’Ulm. Al-Suwailem, S. (2002). Decision-making under uncertainty: an Islamic perspective. In: Iqbal, M. and Llewellyn, D. (Eds.), Islamic Banking and Finance: New Perspectives on Profit Sharing and Risk. Cheltenham: Edward Elgar Publishing, pp. 15–36. Anderlini, L. and Sabourian, H. (1992). Some notes on the economics of barter, money and credit. See Humphrey. Battaglia, D. (1992). The body in the gift: memory and forgetting in Sabarl mortuary exchange. American Ethnologist, 9(1), 3–18. Beck, U. (1999). World Risk Society. Cambridge: Polity. Brantlinger, P. (1996). Fictions of State: Culture and Credit in Britain. Ithaca, NY: Cornell University Press. Chu, J. Y. (2010). Cosmologies of Credit: Transnational Mobility and the Politics of Destination in China. Durham, NC: Duke University Press. Drunen, L. D. (2015). Debt, Risk and grace. Journal of Market and Morality, 18(1), 61–79. Dunn, E. C. (2004). Privatizing Poland: Baby Food, Big Business, and the Remaking of Labor. Ithaca, NY: Cornell University Press. Durrenberger, E. P. and Palsson, G. (2015). Gambling Debt: Iceland’s Rise and Fall in the Global Economy. Boulder: University Press of Colorado. Gregersen, N. H. (2003). Risk and religion: toward a theology of risk taking. Zygon, 38(2), 355–376. Gregory, C.A. (2012). On money debt and morality: some reflections on the contribution of economic anthropology. Social Anthropology/Anthropologie Sociale, 20(4), 380–396. Gudeman, S. F. (2001). The Anthropology of Economy: Community, Market, and Culture. Malden, MA: Blackwell.

69

TOSEEF AZID ET AL.

Guha, R. (1985). The career of an anti-god in heaven and on earth. In: A. Mitra (Ed.), The Truth Unites: Essays in Tribute to Samar Sen. Calcutta: Subarnarekha, pp. 1–25. Heinemann, T. (2010). The Micro Debt: A Critical Investigation into the Dark Side of Microcredit (a Film). København: Heinemann Media. Howe, L. (1998). Scrounger, worker, beggarman, cheat: the dynamics of unemployment and the politics of resistance in Belfast. Journal of the Royal Anthropological Institute, 4(3), 531–550. Kwon H. (2007). The dollarization of Vietnamese ghost money. Journal of the Royal Anthropological Institute, 13(1), 73–90. Lee, Y. and David, R. (2010). Suicides in India revealing how men made a mess of microcredit. Bloomberg Markets Magazine, 28 December. L’evi-Strauss, C. (1969 [1949]). Elementary Structures of Kinship, transl. Bell, J. H. and von Sturmer, J. R. and Needham, R. Boston, MA: Beacon. From French. Leyshon, A. and Thrift, N. (1999). Lists come alive: electronic systems of knowledge and the rise of credit-scoring in retail banking. Economics Society, 28(3), 434–466. Lowrey, K. (2006). Salamanca and the city: culture credits, nature credits, and the modern moral economy of indigenous Bolivia. Journal of the Royal Anthropological Institute, 12(2), 275–292. Luhmann, N. ([1968] 1973). Vertrauen. Ein Mechanismus der Reduktion sozialer. ISBN(eBook) 978-3-8463-4004-2. MacDonald, G. (2000). Economies and personhood: demand sharing among theWiradjuri of New South Wales. In: Wenzel, G. W., Hovelsrud-Broda, G. and Kishigami, N. (Eds.), The Social Economy of Sharing: Resource Allocation and Modern Hunter-Gatherers. Osaka: National Museum of Ethnology, pp. 87–111. Malinowski, B. (1922). Argonauts of the Western Pacific. New York: Dutton, 1961. Maurer, B. (2006). Pious Property: Islamic Mortgages in the United States. New York: Russell Sage Found. Mauss, M. (1954). The Gift Forms and Functions of Exchange in Archaic Societies. Glencoe, IL: Free Press. Mauss, M. (1990). The Gift: The Form and Reason for Exchange in Archaic Societies. London: W.W. Norton. Minsky, H. P. (1993). Finance and Stability: The Limits of Capitalism, Hyman P. Minsky Archive. 43. https://digitalcommons.bard.edu/hm_archive/43. Nelson, B. (1969). The Idea of Usury: From Tribal Brotherhood to Universal Otherhood. Chicago, IL: Chicago. Nugent, D. (1996). From devil pacts to drug deals: commerce, unnatural accumulation, and moral community in “modern” Peru. American Ethnologist, 23(2), 258–290. Papataxiarchis, E. (1999). A contest with money: gambling and the politics of disinterested sociality in Aegean Greece. Lilies of the field: marginal people who live for the moment. Boulder, CO: Westview Press, pp. 158–175. Peebles, G. (2010). The anthropology of credit and debt. Annual Review of Anthropology, 39, 225–240. Pietz, W. (1997). Death of the deodand: accursed objects and the money value of human life. Anthropology and Aesthetics 31(Spring), 97–108.

70

D E B T, R I S K , A N D I S L A M I C M O R A L E C O N O M Y

Polanyi, K. (1944). The Great Transformation: The Political and Economic Origins of Our Time. Boston, MA: Beacon Press. Rahner, K. (1975). On the theology of hope. In: Rahner Reader, A. (Ed.), Gerald McCool. London: Darton, Longman and Todd, pp. 224–238. Rescher, N. (1983). Risk: A Philosophical Introduction to the Theory of Risk Evaluation and Management. Washington, D.C.: University Press of America. Roitman, J. (2005). Fiscal Disobedience: An Anthropology of Economic Regulation in Central Africa. Princeton, NJ: Princeton University Press. Sahlins, M. (1972). Stone Age Economics. Chicago, IL: Aldine. Sharp, L. A. (2000). The commodification of the body and its parts. Annual Review of Anthropology, 29, 303. doi: 10.1146/annurev.anthro.29.1.287. Sneath, D. (2006). Transacting and enacting: corruption, obligation and the use of monies in Mongolia. Ethnos, 71(1), 89–112. Song, J. (2009). South Koreans in the Debt Crisis: The Creation of a Neoliberal Welfare Society. Durham, NC: Duke University Press. Stiansen, E. and Guyer, J. I. (Eds.) (1999). Credit, Currencies and Culture: African Financial Institutions in Historical Perspective. Stockholm: Nordiska Afrikainstitutet. Strathern, M. (1975). No Money on Our Skins: Hagen Migrants in Port Moresby. Canberra: New Guinea Research Unit Bulletin No. 61. Taussig, M. (1987). Shamanism, Colonialism, and the Wild Man: A Study in Terror and Healing. Chicago: University Chicago Press. Thomas, N. (1991). Entangled Objects: Exchange, Material Culture, and Colonialism in the Pacific. Cambridge, MA: Harvard University Press. Trautmann, T. R. (1981). Dravidian Kinship. Cambridge: Cambridge University Press. Truitt, A. (2007). Hot loans and cold cash in Saigon. In: Truitt, A. and Senders, S. (Eds.), Money: Ethnographic Encounters, pp. 57–67. Oxford: Berg. van Binsbergen, W. M. J. and Geschiere, P. (Eds.) (2005). Commodification: Things, Agency, and Identities (The Social Life of Things Revisited). Münster: Lit Verlag. Verdery, K. (2003). The Vanishing Hectare: Property and Value in Postsocialist Transylvania. Ithaca, NY: Cornell University Press. Woodburn, J. (1982). Egalitarian societies. Man, 17(3), 431–451. Zelizer, V. A. (1994). The Social Meaning of Money: Pin Money, Paychecks, Poor Relief, and Other Currencies. New York: Basic Books.

71

6 ROLE OF THE STATE BANK’S POLICY RATE IN PAKISTAN’S ECONOMY Atiq ur Rehman 6.1 Introduction The Pakistani government has been facing a serious fiscal stress and the recent budget is an indication of this stress. The main contributor to this fiscal stress is the servicing of public debt. Out of a budget of Rs. 7,288 billion, an amount of Rs. 2,531 billion is allocated for ‘markup payments on domestic debt’, which comprises 34.7% of the total budget. Apart from the markup on domestic debt, Rs. 359 billion is reserved for markup on external debt, and Rs. 1,095 billion is reserved for the repayment of external debt, which comprises 4.9% and 15.0% of the total budget. Therefore, the total allocation for the debt servicing is Rs. 3,985 billion, with 54.7% share in the total budget. It is important to note that in April 2018 when the previous government presented her budget for fiscal year 2018–2019, the amount of domestic public debt was Rs. 16,210 billion, and they reserved Rs. 1,391 billion for markup payments on this domestic public debt. In April 2019, when the incumbent government was preparing her budget for fiscal year 2019–2020, the domestic public debt had risen to Rs. 18,530 billion, and the government allocated 2,531 billion for markup payments. This shows that during one year, domestic public debt increased by 14.3%, and markup payments on this debt increased by 82%, making it the largest head of expenditures in the budget. Markup payments have risen at a much faster rate, and this fast rise has shaped the current budget. Certainly this rise in markup payment has added to the fiscal stress. The average rate of markup, that is, the markup to debt ratio for the allocations by the previous government turns out to be 8.6% and for the incumbent government, it is 13.7%. If the markup to debt ratio for the current fiscal year was equal to that of the previous year, the government would need to allocate Rs. 1,590 billion for markup payments. But because of the rise in this ratio, the government has to allocate an additional 961 billion, with a total of 2,531 billion allocated for markup payments. The major reason for this fast rise in payable markup is the change in policy rate. When the previous government prepared the budget for fiscal 72

DOI: 10.4324/9781003050209-6

ROL E OF SBP ’ S P OL IC Y R AT E

year 2018–2019, the policy rate was 5.75%, and the markup to debt ratio dependent on the policy rate was 8.3%. When the present government was preparing the budget, the policy rate had risen to 12.25%, and the resultant markup to debt ratio was 13.7%. Thus, the rise in policy rate has led to a disproportionate rise in markup payable. In July 2019, the Monetary Policy Committee had increased the policy rate further by 1%, which may result in further higher expenditures in this head during the current fiscal year. According to the data available on the website of the State Bank of Pakistan (SBP),1 by April 2019, about 60% of the domestic public debt was short-term debt, and most of this short-term debt was in the form of three months’ treasury bills. This debt needs a repayment at maturity of the tenure, and for this repayment, the government needs to sell new treasury bills in the market. The markup on these new treasury bills would be determined by the current policy rate. If the policy rate goes up, the markup on recently sold treasury bills also goes up. Therefore, the policy rate directly affects markup payments and contributes to the fiscal stress. The policy rate is an instrument used by central banks to achieve certain objectives including price stability and growth. The current monetary policy practices are based on inflation targeting framework, where inflation is regarded as the primary objective of the central bank’s monetary policy and interest rate (policy rate) is used to achieve this objective. If the central banks foresee that the inflation is going to be higher than the target inflation, the bank increases interest rate, hoping to reduce inflation, and vice versa. The action of the central bank is based on the assumption that there should be a negative relationship between interest rates and inflation. In contrast, there are numerous studies as those of Gibson (1923), Rehman (2015), Rehman (2017), Al-Marhubi (1997), Bart et al. (2001), and Albaresi (2007) with the finding that the relationship between interest rates and inflation is positive; that is, if the interest rate increases, inflation also increases. This phenomenon was taken as a paradox by mainstream economists; however, there is a well-established theory known as ‘Cost Channel of Monetary Transmission’, which explains why there could be a positive association between interest rates and inflation. The rise in markup payable also exerts upward pressure on inflation because it increases the demand for taxes, which become part of the prices of goods and services. The positive association between interest rates and inflation deserves serious attention because if it is actually true, then a tight monetary policy would on one hand increase the fiscal stress, and on the other hand, it will be counterproductive for controlling inflation. The purpose of this study is to analyze the consequences of an increase in policy rates and to review whether or not the monetary policy can achieve its objectives through the policy rate. The rest of this chapter is organized as follows. 73

A tiq ur R ehman

6.1.1 Why raise policy rate? Since the policy rate determines the markup on a government’s own debt obligation, why do governments/central banks raise policy rates? The answer to this question lies in the so-called interest rate channel and other demand side channels of monetary transmission. There are several causal paths through which the monetary policy decision can affect its target variables, and these channels are often referred to as monetary transmission channels (Mishkin, 1996). Most important of these channels is called the interest rate channel. The interest rate channel says that the tight monetary policy would initially increase the short-term interest rates, which will then increase the longer-term interest rates. The rise in interest rate will reduce the current consumption, and therefore the aggregate demand reduces and finally inflation reduces. This is the most popular channel that is usually mentioned in standard textbooks and it is used for actual monetary policy making. The monetary policy decision rules such as the Taylor Rule and McCallum Rule are based on the assumption of the validity of the interest rate channel. The same channel has been used for policy making throughout history. Based on this logic, recent monetary policy making has adapted a framework, labeled as ‘Inflation Targeting Framework’. Inflation in this framework has been set as the primary target of monetary policy and the interest rate is set as the primary tool. The background assumption of the inflation targeting framework is that by increasing interest rate, inflation can be reduced. Therefore, interest rate is reduced to allow growth and increased to reduce inflation. There are some other objectives that are assumed to be achieved through the monetary policy, but practically, these other objectives have become ‘minor’ objectives. The most important objective, as the name indicates, is inflation. Therefore, Laurence H. Meyer, Member of the Board of Governors of the US Federal Reserve System, in one of his speeches stated that central banks typically operate under one of two types of mandate. A hierarchical mandate makes price stability the primary objective for monetary policy and subordinates other potential objectives. A dual mandate recognizes two objectives – price stability and full employment – and puts them on an equal footing. Either regime could make the price stability objective more precise by setting an explicit numerical target for inflation. In Pakistan, employment is one of the least cited terms in monetary policy statements, and the term has not appeared anywhere in the State Bank of Pakistan Act, 1956, which provides the legal cover to the SBP and the Monetary Policy Committee. Therefore, the core objective of the monetary policy is inflation, with several minor objectives. The minor objectives of the central banks’ monetary policy include growth and the exchange rate stability. To allow growth, the central banks 74

ROL E OF SBP ’ S P OL IC Y R AT E

use a loose monetary policy and decrease the interest rate. It is assumed that the loose monetary policy will allow people to consume, which will bring about a boom in the economy. The rising consumption will motivate firms to produce more; therefore, GDP will grow. Increased production will need increased labor activity; therefore, employment will increase. On the other hand, if the central banks foresee an economy to be overheated and likely to produce high inflation, the central banks use a tight monetary policy and an increased interest rate to reduce inflation and the economic activity as well. Sometimes a tight monetary policy is used to maintain/improve the stock of foreign exchange reserves and/or to prevent depreciating exchange rates. It is assumed that if the interest rate in the local market is higher than in the foreign markets, investors would like to invest in the domestic currency to exploit this high interest rate and earn a higher profit. In the past 12 months, the interest rate in Pakistan was increased continuously by the SBP’s Monetary Policy Committee. The central bank’s policy rate had reached 13.25% in July 2019 from 5.75% in July 2018. The analysis of monetary policy statements released by the SBP reveals that the primary objective for this policy rate hike has been inflation. Sometimes, the falling reserves, exchange rate, fiscal deficit, etc. are also factors that affect monetary policy making, but the first and foremost reason stated for a policy rate hike consistently has been inflation. 6.1.2 Did a tight monetary policy improve foreign exchange reserves? As stated above, one of the objectives of the use of a tight monetary policy is to attract foreign investment and to maintain foreign exchange reserves. Unfortunately, in Pakistan, despite such a rise in the policy rate and the consequent rise in other kinds of interest rates, no unusual rise in the foreign direct investment (FDI) or other kinds of foreign exchange inflow is observable. Probably this is because the exchange rate during the period has been falling continuously. Figure 6.1 shows the FDI inflows in Pakistan during 2010–2019. The vertical bar corresponds to July 2018, when the monetary tightening started. It can be seen that the average FDI inflow was higher before July 2018, when the interest rate was low and the average of FDI after July 2018 is lesser, despite such a huge increase in the interest rate. Actually, the falling exchange rate leaves no attraction for foreign investors. It is true that the interest rate in Pakistan is much higher than that of its peer economies, and it should serve as an attraction for foreign investors; however, any investment in local currency may yield negative returns for foreign investors owing to the falling value of the rupee. Therefore, the data do not show any rise in the foreign exchange inflow despite such a high rise in the interest rate. Because of no improvement in the foreign exchange inflows, the foreign exchange reserves also suffer. Figure 6.2 shows the position of foreign 75

A tiq ur R ehman

7

Discount Rate Inflation

6 5 4 3 2 1

Jan-20

Sep-18

May-19

Jan-18

May-17

Jan-16

Sep-16

May-15

Jan-14

Sep-14

May-13

Jan-12

Sep-12

May-11

Jan-10

Sep-10

Sep-08

May-09

Jan-08

May-07

Jan-06

-2

Sep-06

0 -1 -3

Figure 6.1 Foreign Direct Investment in Pakistan 2010–2019. 30,000 25,000

Reserves With SBP

Reserves With Banks

Total Liquid Reserves

20,000 15,000 10,000 5,000 0

Figure 6.2 Foreign Exchange Reserves in Pakistan 2011–2019.

exchange reserves in Pakistan. The vertical line again corresponds to July 2018 when monetary tightening started. It can be observed that foreign exchange reserves did not improve after the monetary tightening. The reserves occupy a much better position in 2016–2017, when the interest rate was 5.75%, the lowest in the history of Pakistan. 6.1.3 Did a tight monetary policy reduce inflation in Pakistan? The SBP increased interest rates with the hope of reducing inflation. But historical data show high interest rates were never successful in curtailing inflation as is evident from the following statements. In 2009, the policy rate was about 12%, and the inflation was also close to 12%. During 2016–2017, the interest rate was reduced to 5.75%, and the inflation during this period was about 4%. Recently, the interest rate had risen

76

ROL E OF SBP ’ S P OL IC Y R AT E

16 14

Policy Rate

Inflation

12 10 8 6 4 2 Jul-19

Jan-20

Jul-18

Jan-19

Jul-17

Jan-18

Jul-16

Jan-17

Jul-15

Jan-16

Jul-14

Jan-15

Jul-13

Jan-14

Jan-13

Jul-12

Jan-12

Jul-11

Jan-11

0

Figure 6.3 YoY Inflation in Pakistan 2009–2019.

to 13.25%, and despite such a high interest rate, the consumer price inflation is at 9% and the wholesale price inflation is at 12%. This implies that high interest rates did not reduce inflation, and the two variables move together in the same direction. They increase together and decrease together, contrary to the assumption of the SBP that inflation can be brought down by increasing the interest rate (Figure 6.3). 6.1.3.1 Relation between interest rates and inflation: historical perspective Throughout the history of monetary economics, a dominant class of monetary theorists have been assuming that there should be a negative relationship between interest rate and inflation. In contrast, data have proved to be evidence against this assumption. The first important evidence in this regard is from Gibson (1923), who analyzed the historical data for United Kingdom for about 200 years and found that there is a positive association between nominal interest rate and inflation. This was such a strong observation that the legendary economist John Maynard Keynes referred to this observation as the ‘most established fact in the whole field of quantitative economics’ (Keynes, 1930). Keynes, however, cannot find a theoretical justification for this observation and referred to this observation as a paradox, often called Gibson Paradox. Covallo (1977) in his PhD thesis also found a positive relationship between interest rate and prices. The Nobel Laureate Christopher Sims in his seminal paper, failed to find evidences in support of the classical interest rate channel, and found evidences for a positive association between two variables (Sims, 1992). As for the observation of Gibson (1923), the dominant stream of economists at the time of Sims was unable to comprehend the

77

A tiq ur R ehman

theory behind this observation and referred to this observation as a ‘price puzzle’. The historical data from the United States show that since 1960, the correlation between interest rate and inflation has been positive for every period. Table 6.1 summarizes the correlation between a three-month Treasury bill rate and YoY inflation for the United States separately for every decade. The US data for the past 19 years clearly depict the positive relationship between nominal interest rate and inflation. The average discount rate in the US before December 2007 was approximately 3%, and the average of inflation was also about 3%. To cope with the Global Financial Crisis of 2007, the federal fund rate was reduced to less than 0.5%. The federal fund rate in the US remained below 1% for a long period starting from November 2008 until June 2017. According to conventional understanding, such a reduction in interest rate should inflame inflation. However, for the period 2008–2017 when the interest rate was less than 1%, average inflation had been only 1.4%, much smaller than the average inflation of the pre-crisis period 2000– 2007, when the interest rate was much higher (Figure 6.4). Table 6.1 Correlation between the Three-Month Treasury Bill Rate and YoY Inflation for the US in the Past Six Decades Jan 1960 to Dec 1969 Jan 1970 to Dec 1979 Jan 1980 to Dec 1989 Jan 1990 to Dec 1999 Jan 2000 to Dec 2009 Jan 2010 to Jul 2019

7

92% 79% 74% 56% 51% 22%

Discount Rate Inflation

6 5 4 3 2 1

Figure 6.4 YoY Inflation in the US 2005–2020.

78

Jan-20

Sep-18

May-19

Jan-18

May-17

Jan-16

Sep-16

May-15

Jan-14

-3

Sep-14

Sep-12

May-13

Jan-12

May-11

Jan-10

Sep-10

May-09

Jan-08

Sep-08

May-07

Jan-06

-2

Sep-06

0 -1

ROL E OF SBP ’ S P OL IC Y R AT E

Table 6.2 Correlation between Inflation and Lagged Interest Rate in the US 1960-01-01 1970-01-01 1980-01-01 1990-01-01 2000-01-01 2010-01-01

93% 82% 73% 57% 51% 22%

93% 84% 73% 58% 51% 22%

93% 85% 71% 58% 49% 22%

92% 87% 69% 58% 48% 22%

Sometimes it is argued that the interest rate is increased today to reduce future inflation, therefore, the effect of policy rate hike should appear with some lag. On the other hand, some people argue that the future inflation is used for deciding the current interest rate; therefore, a lag is necessary to analyze the impact of policy rate on inflation. With this argument, there should be a negative relation between inflation and the lag interest rate. To analyze the validity of this argument, we found a correlation between inflation and lagged interest rate for the US data over several decades and the results are given in Table 6.2. It is easily observable that the relationship between two variables remains positive regardless of the values of lags. Rehman (2015) and Rehman (2016) studied the relationship between interest rate and inflation for a very large data set covering the entire globe. Rehman used different measures of interest rate and inflation, different sample sizes, and a variety of control variables. According to these two studies, for about 60% of the cases, the impact of interest rate on inflation turned out to be positive, and about 33% of the time, it turned out to be insignificant. The negative association that supports the existence of the so-called demand channel or the interest rate channel was observed in 7% of all cases. Rehman (2016) shows that the phenomenon is robust to sample size, sample period, combination of control variables used in the analysis, and the lag specification. The phenomenon exists throughout the globe, regardless of the income categorization of the country. Ghaffari and Rehman (2016) analyze the relationship between interest rate and inflation for Pakistan. They also use different combinations and specifications of control variables, and their findings provide no support to the classical demand channel. 6.1.4 What derives the positive association between interest rate and inflation? For most economists, a theory that can explain the positive association between interest rate and inflation does not exist. Therefore, the observations finding such phenomenon are labeled as a paradox and/or a puzzle.

79

A tiq ur R ehman

In contrast, one of the earliest theories, the monetary theory, explains how interest rate and inflation could be positively associated. Thomas Tooke (1774–1858) is often referred to as the father of monetary economics and he is the first person to write a book on price dynamics, which is the central objective of the contemporary monetary policy. He is the pioneer of a famous ‘Banking School Theory’, that was the alternative of the ‘Currency School Theory’. Tooke argues that the interest rate is a part of the cost of production; therefore, a rise in the interest rate would increase the cost of production, and, consequently, would raise the level of prices. Gibson’s (1923) findings that were referred to as paradoxical were actually a verification of the theory of Thomas Tooke; however, the mainstream view about the relationship between interest rate and prices was so popular that even Keynes was skeptical about the presence of any alternate theory, and he referred to the findings of Gibson (1923) as paradoxical. There were several attempts to explain this paradox during the decades until the 1970s. In the 1970s, cost-side economics came into the limelight. The positive association between interest rates and inflation was explained by the ‘Cost Channel of Monetary Transmission’. The cost channel was actually a reinvention of the theory of Thomas Tooke who had predicted the same more than a century ago. The cost channel says that the interest affects the cost of working capital and the production cost. There were many evidences favoring the cost channel at the aggregate data. However, if the cost channel was actually working, the interest rate should at first effect the price of working capital and the cost of a firm’s production. A number of researchers took the firm-level data to investigate the relationship and found evidences in support of the theory. 6.1.4.1 Interest rate and inflation in heavily indebted countries Besides the cost channel of monetary transmission, there is another channel through which the rise in interest rate can raise inflation. This channel would be more prominent for the economies where the domestic debt to the GDP ratio is high. Consider a country with a high domestic debt to GDP ratio. The most popular instrument through which governments borrow from the markets are the government securities that may be short term and/or long term. The short-term securities are often called treasury bills, whereas the long-term securities carry different names in different countries. The short-term securities can have a maturity period ranging from one day to one year. In Pakistan, short-term securities have a maturity period ranging from three months to one year. The change in policy rate affects the amount of markup payable on shortterm securities. Governments have the following options to finance the markup on these securities 80

ROL E OF SBP ’ S P OL IC Y R AT E

• • •

Print money and pay the lenders Increase the taxes and pay the lenders Take more loans from the lenders to repay the maturing securities

Usually it is thought that option 1, that is, printing money would bring about inflation, and therefore governments tend to opt for options 2 and 3 for financing the markup. It can be easily shown that these options are also inflationary. This also indicates that if markup is increased, the need for money from any of the three options listed would be higher and the resultant inflation would also be higher. 6.1.5 Interest rate, markup payments, tax inflation channel Suppose to control inflation, the government has increased the interest rate. This increase will increase the markup on short-term treasury bills. Since the treasury bills are a short-term debt instrument, the government would have to repay the debt along with markup within the maturity period. Governments also want to maintain the debt to GDP ratio; therefore, they opt to raise taxes to pay the markup. These taxes become part of the price and raise inflation. It is also possible for the government to choose further borrowing instead of raising taxes to finance the increased markup. Suppose the government has taken an amount of debt D and the interest rate for the tenure is i percent. At maturity, the government would need amount D(1 + i%) to finance the debt. Therefore, on every next maturity, the amount needed by the government to pay its obligation will keep increasing. Ultimately, the commercial banks that are lending to the government, that are not authorized to create currency would be unable to lend further. The government would need to come back to the central bank for the bailout and the money would need to be created. If the interest rate is higher, the stage to return to the central bank would approach faster. On the other hand, if the interest rate is lower, it will take longer to come back to the central bank and less amount of money would need to be created. Therefore, higher interest rate would lead to higher inflation. Therefore, in highly indebted countries, an attempt to control inflation by increasing the interest rates would lead to higher inflation. This is one of the reasons why historical data do not support the popular interest rate channel. The presence of this channel provides another explanation of the positive association between interest rate and inflation, which was found in historical data by many famous economists including Nobel Laureate Christopher Sims. 6.1.6 Central bank borrowing is not necessarily inflationary As we have seen, increasing the interest rate to control inflation would increase the markup payable on the government’s debt and there are three 81

A tiq ur R ehman

options to finance these increased obligations, as mentioned in Section 6.1.4.1. It is usually argued that only option 1, that is, printing money is inflationary, but not the other two options. We have shown in Section 6.1.5 that options 2 and 3 are also inflationary. This section shows that option 1, which is considered inflationary, is actually not inflationary if certain conditions are fulfilled. Basically, domestic debt per se is a result of the attempt to avoid money printing. Sovereign governments are authorized to print their currency as and when needed. After the fall of Gold Standards System, there is no restriction on the governments about the amount of money they can print. Despite this, the governments opt for the less popular way to impose taxes and use other methods of revenue collection, instead of choosing to print money. This happens primarily to avoid the possibility of high inflation. There are several economies that used to print excessive money to finance their budget expenditures and many of such attempts landed in hyperinflations creating a disaster for the economy. Bernholz (2015) has studied 29 hyperinflations in his famous book Monetary Regimes and Inflation: History, Economic and Political Relationships, and found that at least 25 of these hyperinflations are caused by the excessive printing of money. The major cause of the recent hyperinflation in Venezuela with the inflation exceeding 1.6 million percent in 2018 was excessive money printing. However, under certain conditions, printing money would not be inflationary. The Modern Monetary Theory has much to say about when and how printing money is not inflationary. However, regardless of the Modern Monetary Theory, classical economics also suggests some conditions under which money supply may not be inflationary. The famous Quantity theory of money, which is used to predict the relationship between inflation and money supply itself implies that a controlled increase in money supply may not necessarily lead to inflation. We have: MV = PY where M is the amount of money supply, V is the velocity of money, P is the aggregate price level, and Y is aggregate output. This relationship can be rewritten as follows: M P = V  Y Assuming the velocity of money to be constant, if M increases, so happens with P as well. Therefore, classical economists assume that there would be a one-on-one relationship between inflation and money supply. In fact, an

82

ROL E OF SBP ’ S P OL IC Y R AT E

increase in M leads to an increase in P if Y doesn’t increase. If M and Y change by the same proportion, there would be no change in the price level P. Therefore, even within the classical economic framework, suppose money supply is increased to finance the new economic activity that was not there in the economy, which means Y is also increasing with the increase in M. If the two variables grow at the same rate, there should be no inflationary effect. Unfortunately, this factor is ruled out in the usual discussion and it is assumed that the change in money supply would lead to inflation. 6.1.7 High interest rate and inflation in Pakistan As discussed earlier, the central banks increase the interest rate to reduce inflation, but this move increases the amount of markup payable in debt servicing. To finance this debt servicing, the government has taken a few stringent initiatives such as reduction in subsidies and increase in taxes for a number of reasons. A number of studies have shown that the oil prices in Pakistan have a significant impact on aggregate inflation. These studies include those of Rehman (2016, 2017). There is a very direct linkage between oil price and the aggregate price level. The rise in oil prices increase the communication cost and manufacturing costs of almost all the goods, and therefore, affect the prices of all goods. In more recent history, the price of the Pakistani rupee has gone down drastically against the US dollar, raising the import price of petroleum products. Since the tenure of the previous government, there is a heavy petroleum development levy imposed on the petroleum products besides the general sales tax. The previous government has been using petroleum development levy as a price smoothening tool for petroleum products. The present government has shown resistance to the reduction in petroleum development levy and has passed the entire burden of devaluation to the consumers. This has generated a huge inflationary episode. Then, to tackle the resultant inflation, the government has used a tight monetary policy and has consistently raised the policy rate from 5.75% in January 2018 to 13.25% in July 2019. The hike in policy rate has raised the markup payable on the domestic debt drastically. With 20 trillion domestic debts, a 1% rise in the policy rate costs the government by 200 billion in markup payment. Suppose instead of controlling inflation by using high markup, the government opts to reduce the petroleum development levy so that the price of petroleum products can be reduced. This reduction in the cost of petroleum products will exert a downward pull in the prices of all commodities and inflation can be reduced. The option to stop the 1% rise in the interest rate would save 200 billion in terms of markup payment and the same saving can be used to finance this reduction in the petroleum development levy.

83

AT IQ U R R EH M A N

6.1.8 Reducing inflation by reducing the interest rate It can be shown that inflation can be reduced significantly by reducing the interest rate. It is discussed in Section 6.1 that if the policy rate were fixed at the level of January 2018, the country would need only 1,590 billion to finance the markup payment, and because of the rise in interest rate, it needs to allocate an additional 961 billion so that total allocation for markup payment will become 2,531 billion. This means, the other factor remains the same, if the interest rate is brought down to the inflation level of January 2018, the amount required to pay the markup on the present domestic public debt can be reduced by about 960 billion. The requirement for tax collection would also reduce by the same amount. The government can manage to abolish the petroleum development levy and can also manage a significant reduction in general sales tax without affecting any of the budget allocation. Obviously, such a reduction would reduce inflation as well.

6.2 Conclusion The SBP opts to increase the interest rates in the hope of reducing inflation. In contrast, the historic data from Pakistan and many other parts of the globe suggest that there is a positive association between the two variables. This means that monetary policy is counterproductive. The existing literature explains this phenomenon using a cost channel. This chapter argues that besides the cost channel, the markup payment on domestic public debt also has the potential to explain the positive association. This chapter shows that if the policy rate is reduced, markup payments on domestic debt can be reduced, which will reduce the demand for taxes. A reduction in the demand for taxes can help in achieving a low inflation target. The major reason for the fiscal stress faced by the incumbent government is the markup payment on domestic debt and this markup payment is associated with the policy rate. By reducing the policy rate, the government can simultaneously achieve the goals of low inflation and lower fiscal stress.

Note 1 http://www.sbp.org.pk/ecodata/CenGovDebt-Archive.xls.

References Albanesi, S. (2007). Inflation and inequality. Journal of Monetary Economics, 54(4), 1088–1114. Al-Marhubi, F. (1997). A note on the link between income inequality and inflation. Economics Letters, 55(3), 317–319. Barth III, M. J., & Ramey, V. A. (2001). The cost channel of monetary transmission. NBER Macroeconomics Annual, 16, 199–240.

84

ROL E OF SBP ’ S P OL IC Y R AT E

Bernholz, P. (2015). Monetary Regimes and Inflation: History, Economic and Political Relationships. Cheltenham: Edward Elgar Publishing. Covallo, D. F. (1977). Stagflationary effects of monetarist stabilization policies. A PhD thesis submitted to The Department of Economics, Harvard University Cambridge, MA, April 1977. Chowdhury, I., Hoffmann, M., & Schabert, A. (2006). Inflation dynamics and the cost channel of monetary transmission. European Economic Review, 50, 995–1016. Coibion, O., Gorodnichenko, Y., Kueng, L., & Silvia, J. (2012). Innocent bystanders? Monetary policy and inequality in the US (No. w18170). National Bureau of Economic Research. doi: 10.3386/w18170. Di Tella, R., MacCulloch, R. J., & Oswald, A. J. (2001). Preferences over inflation and unemployment: Evidence from surveys of happiness. The American Economic Review, 91(1), 335–341. Easterly, W., & Fischer, S. (2001). Inflation and the Poor. Journal of Money, Credit and Banking, 33(2), 160–178. Faria, J. R., & Carneiro, F. G. (2001). Does high inflation affect growth in the long and short run? Journal of Applied Economics, 4(1), 89–105. Fowler, S. J. (2005). Income Inequality, Monetary Policy, and the Business Cycle. Working Papers 200507, Middle Tennessee State University, Department of Economics and Finance. Fuhrer, J. (1994). Optimal monetary policy and the sacrifice ratio. In Conference Series; [Proceedings] (Vol. 38, pp. 43–84). Federal Reserve Bank of Boston, Boston. Fuhrer, J. C., & Moore, G. R. (1995). Monetary policy trade-offs and the correlation between nominal interest rates and real output. The American Economic Review, 85(1), 219–239. Gali, J. (2001). Monetary Policy in Early Years of EMU, unpublished manuscript, Barcelona: Pompeu Fabra University. Ghaffari, A., & Rehman, A. U. (2016). Failure of interest based monetary policy: Evidences from selected Islamic and non-Islamic countries. Pakistan Business Review, 17(4), 731–753. Ghaffari, A. B., Rehman, A., & Muhammad, M. (2014). Interest rate and inflation: A case study of Pakistan. Pakistan Business Review, 16(3), 451–515.. Gibson, A. H. (1923). The future course of high class investment values. Banker’s Magazine (London), 115, 15–34. Hunt, B. (2006). Oil price shocks and the US stagflation of the 1970s: Some insights from GEM. The Energy Journal, 27(4), 61–80. Mersch, Y. (2014, October). Monetary policy and economic inequality. In Keynote speech, Corporate Credit Conference, Zurich (October 17). Mishkin, F. S. (2001). From Monetary Targeting to Inflation Targeting (No. 2684). Washington, DC: World Bank Publications. Myrdal, G. (1939). Monetary Equilibrium. London: William Hodge. Niggle, C. J. (1989). Monetary policy and changes in income distribution. Journal of Economic Issues, 23(3), 809–822. Nordhaus, W. D. (1973). The effects of inflation on the distribution of economic welfare. Journal of Money, Credit and Banking, 5(1), 465–504. Sims, C. A. (1992). Interpreting the macroeconomic time series facts: The effects of monetary policy. European Economic Review, 36(5), 975–1000.

85

A tiq ur R ehman

Ravenna, F., & Walsh, C. E. (2006). Optimal monetary policy with the cost channel. Journal of Monetary Economics, 53, 199–216. Rehman, A. U. (2015). Revival of legacy of Tooke and Gibson: Implications for monetary policy. Journal of Central Banking Theory and Practice, 4(2), 37–58. Rehman, A. U. (2017). 7 Remittances for Growth: Initiatives for Remitters and Remittances (No. 2017: 147). Pakistan Institute of Development Economics, Islamabad working paper number 147. Rehman, A. U. (2016). Multiple Indicators Hamdani Formula for HEC Journal Recognition and Ranking. Kashmir Economic Review, 25(1), 81–92. Rothbard, M. N. (1994). Austrian economics: Tensions and new directions. Southern Economic Journal, 61(2), 559–561. Serletis, A., & Krause, D. (1996). Empirical evidence on the long-run neutrality hypothesis using low-frequency international data. Economics Letters, 50(3), 323–327. Taylor, J. B. (1993, December). Discretion versus policy rules in practice. In CarnegieRochester Conference Series on Public Policy (Vol. 39, pp. 195–214). North-Holland. Zaman, A. (2010). Anti-poverty policies and anti-poor Philosophies. Journal of Business and Economics, 2(2), 127–137.

86

7 RELIGION, CULTURE, AND ISLAMIC MARKETING Hussain Mohi-ud-Din Qadri

7.1 Influence of religion on marketing Research writings in the field of marketing conclude that religion is a major aspect of culture,1 significantly influencing behavior,2 which resultantly affects purchasing decisions.3 This kind of influence happens in two forms. The first is the direct influence of religious precepts on individual choice. The other is related to the influence of religion on value formation and attitudes (particularly attitudes related to economic issues). Religion is not only confined to types of food and clothing, but it includes a range of norms, customs, and values such as unacceptable and acceptable desires and behavior patterns. Some researchers describe how religion shapes culture: Religion provides meaning and motivations beyond the material aspect of life. What is right and wrong, and what is good and bad. It gives rise to values and attitudes that, in turn, shape the practices or behavior of the culture’s members. Religion (or its traces) is central to a culture. Educational systems, economic systems, political organizations, and social relations are partially or largely determined by religion.4 The followers of Judaism accept the law of Torah. The Torah is complete with guidelines dealing with business. Torah prescribes the rule of honesty in the marketplace, fairness in prices, employer and employee relations, and environmental issues. The Torah states: If you sell something to your neighbor or buy something from your neighbor’s hand, you shall not wrong one another.5 The Bible, the holy book of the Christians gives a number of instructions that can be guidelines for marketers. Lapin6 in his book titled “Business Secrets from the Bible” extracted quotes from the Bible and proposed strategies for DOI: 10.4324/9781003050209-7

87

H ussain M ohi - ud - D in Q adri

businesses success and financial abundance. He is of the view that the Bible clearly states that the focus on other people needs and desires is important, good behavior, truthfulness in dealings, and good planning are essential for success in business. These attributes are also the norms of good marketing. Buddhists follow the teachings of Buddha who taught the Noble Eightfold Path to his followers. The Noble Eightfold path includes right view, right intentions, right speech, right action, right livelihood, right effort, right concentration, and right mindfulness, which describe the good practices of marketing.7 Marketing practices in Buddhism are observed through this eightfold path.8 Islam is an all-embracing religion in which all social relations are defined and determined. To reinforce good behavior in his followers, Allah’s Messenger (Allah bless him and give him peace) inculcated ethics and manners as essential in Islamic religion. They are the spirit of the Islamic way of business and trade.9 That is why the Messenger (Allah bless him and give him peace) said: ُ ْ ِ ُ ‫إنما‬. ‫الخلق‬ َ ِ َ َ ‫لتمم‬ َ ِّ َ ُ ِ ‫بعثت‬ َ َّ ِ ِ َ ْ َ ْ ‫مكارم‬ I have been sent to perfect good character.10 According to Ayisha (may Allah be well pleased with her): ً ُ ُ ‫أحسنهم‬ ً َ ْ ِ ‫المؤمنين‬ ْ ِ ‫إن‬ َّ ِ :‫رسول ِاﷲ‬ ‫بأهله‬ ُ ْ ُ َ ‫قال‬. َ ْ ِ ِ ْ ُ ْ ‫أكمل‬ ْ ُ ُ َ ْ َ َ ‫خلقا‬ ْ ُ ُ َ ْ َ ،‫إيمانا‬ َ َ ِ ِ ْ َ ِ ‫وألطفهم‬ ِ َ ْ َ ‫من‬ Allah’s Messenger (Allah bless him and give him peace) said: The most perfect of the believers, where faith is concerned, is the finest of them in moral character and the kindest of them towards his family.11 Allah’s Messenger (Allah bless him and give him peace) was an excellent model as regards his pious conduct and good manners. He enjoined his followers to adopt the highly developed qualities of good character: the removal of hardships, a benevolent attitude, generous dealing when selling, truthful speech, keeping a promise, and treating people gently. The Prophet (Allah bless him and give him peace) himself, as the following tradition narrated by Khadija (may Allah be well pleased with her) attests, lived all these virtues: َّ ‫ َوت َْق ِري ال‬،‫ب ْال َم ْع ُدو َم‬ ‫ب‬ ُ ‫ َوتُ ْك ِس‬،‫ َوتَ ْح ِم ُل اْل َك َّل‬،‫ص ُل ال َّرِح َم‬ َ ‫ض ْي‬ َ َّ‫إِن‬ ِ ِ‫ َوتُ ِع ْي ُن َع لَ ى نَ َوائ‬،‫ف‬ ِ َ‫ك لَ ت‬ ِّ ‫ْال َح‬. ‫ق‬ You maintain ties of kinship, bear people’s burdens, help the destitute, give hospitality to your guests and help those who have been afflicted by calamities.12

88

R E L I G I O N , C U LT U R E , A N D I S L A M I C M A R K E T I N G

The Holy Quran has described the Prophet’s (Allah bless him and give him peace) manners in the following way: ْ ُ ۡ َ ‫كان‬ َّ ‫وذكر‬ َّ ‫يرجوا‬ َّ ‫رسول‬ ٞ َ َ َ ٌ‫أسوة‬ ۡ َ َّ ۡ ُ َ ‫كان‬ ‫كثي ٗرا‬ َ َ ‫لمن‬ َ َ ‫لقد‬ َ َ َ َ ‫ٱلخر‬ َ ِ ٓ ۡ ‫وٱليوم‬ ِ َ َ‫ٱلل‬ َ ۡ ُ ِ‫ٱلل‬ ِ ُ َ ‫لكم ِفي‬ َ ۡ َ ۡ َ َ‫ٱلل‬ َ ِّ ‫حسنة‬ In truth, in (the sacred person of) Allah’s Messenger there is for you a most perfect and beautiful model (of life) for every such person that expects and aspires to (meeting) Allah and the Last Day and remembers Allah abundantly.13 The Prophet (Allah bless him and give him peace) described the character of a true believer, whether he or she is an employee, a businessperson, a student, a teacher or a preacher. ُ ِ ْ ُ َْ ٌّ ِ ‫والفاجر‬ ٌّ ِ ‫المؤمن‬. ‫لئيم‬ ُ ِ َ ْ َ ‫كريم‬ ٌ ْ ِ َ ‫غر‬ ٌ ْ ِ َ ‫خب‬ The believer is straightforward and noble, and the evildoer is deceitful and ignoble.14 We must emulate Allah’s Messenger (Allah bless him and give him peace) since he is the most excellent example of moral character. His personality is perfect in every regard and serves as a beacon of guidance for the whole humanity. The Islamic religion has laid down a set of regulations so that the faithful might conduct their economic activities and financial and commercial transactions accordingly. The directives are meant to govern the rights and obligations of parties in selling and buying.15 Among scores of Qur’anic verses and hundreds of traditions on business transactions, a strong culture of ethical values regarding sale and purchase is evident. Complying with moral principles in the domain of commerce and trade is a precondition for stimulating robust economic growth. Moreover, there should be no trade tricks or profiteering to deceive customers. Running a business fairly is a form of service to society and hence an act of worship in the eyes of the Lord of the worlds. Some business ethics and norms one can learn from Islam are fairness, integrity, mutual cooperation, and free consent, avoidance of deception and exploitation, and refraining from hiding defects in a salable product.16

7.2 Channels of transformation of culture Religion is considered as a static element in the transformation of culture, and this is a fact that marketers cannot alter or ignore. When it comes to Islam, it becomes truer. In Islam, while acceptability of free will of an individual exists, the “absolute free will” of a believer is nonexistent. If we take this point into account and consider the predestination of Muslims as a

89

H ussain M ohi - ud - D in Q adri

static element, it becomes very difficult to change this strong predestination. Many attempts have been made for the infusion and penetration of secular values into believers, especially Muslims, which weakened religiosity; hence, secularism and modernism are promoted.17 The level of religiosity is the most necessary measure of analyzing consumer behavior.18 It may be expected that the entire population in a target country declares that it belongs to one religion. Declaration and practice are two different things. Practice will have an influence on consumer behavior, but not declaration.19 In Islamic countries, Islam is the dominant religion, but other religions are also practiced, especially Christianity and Buddhism. They also celebrate their traditional and religious events where the government of Islamic countries permits them. In countries like Brunei, the celebrations of Easter are banned, but the Chinese are allowed to celebrate their new year. These celebrations are of great importance for marketers who want to understand the dynamics of a new market. Muslims also have their religious celebrations and traditions as well. Marketers have to understand the dynamics of these celebrations, religious and traditional days, and programs, and it is necessary for new product development and also for expanding one’s business.20 The wave of digitalization changed the ways and means of cultural transformation. The organized and systematic system of schooling up to postgraduation and existence of mass media at large have become new channels of cultural transformation. From children to elders, everyone spends time on surfing the internet, communication through social media, and watching TV. This attitude is not only confined to Western countries, same trends are growing in Muslim countries.21 Muslim countries have a greater percentage of young population and the young population is tech-savvy in adopting more technological tools and using mobile device for accessing different services (Table 7.1). The companies and brands are present in schools in the form of stationary shops, food providers, vending machines, and selling of other goods. Children also bring branded products to schools. So, if the school is not a religious one either wholly or partially, and if no talking of religions is allowed, companies can interfere and inculcate new values in the minds of children who would be their next consumers. This school marketing is now present in Muslim countries as well.22 The media, advertising agencies, marketers, brands, and religion are the sources of cultural transformation in the world. They have a great influence on the minds of people and their thoughts.23 It is important to consider the role of these sources and their moral aspect for supervising their activities. 7.2.1 Symbols of beauty Symbols of beauty generally refer to physical representations of men and women. In this case, marketers have two opportunities: selling beauty or 90

R E L I G I O N , C U LT U R E , A N D I S L A M I C M A R K E T I N G

Table 7.1 Internet and Social Media Users in Muslim Countries Country

Total Population in Million

Afghanistan 35.95 Albania 2.93 Algeria 41.66 Azerbaijan 9.88 Bahrain 1.53 Bangladesh 165.5 Brunei 431.4 Darussalam Egypt 98.46 Ethiopia 106.2 Gambia 2.13 Ghana 29.15 Guinea 12.88 Guinea-Bissau 1.88 Indonesia 265.4 Iran 81.59 Iraq 38.81 Jordan 9.8 Kazakhstan 18.3 Kenya 50.3 Kosovo 1.78 Kuwait 4.17 Kyrgyzstan 6.09 Lebanon 6.09 Libya 6.42 Malaysia 31.83 Maldives 440.3 Mali 18.82 Mauritania 4.48 Mayotte 256.4 thousand Morocco 35.97 Niger 21.89 Oman 4.73 Pakistan 198.9 Palestine 4.99 Qatar 2.67 Saudi Arabia 33.25 Senegal 16.07 Somalia 14.96 Sudan 41.02 Syria 18.28 Tajikistan 9.01 Tunisia 11.6 Turkey 81.33 Turkmenistan 5.8 UAE 9.47 Uzbekistan 32.14 Yemen 28.58

Internet Users in Millions

Active Social Mobile Media Users Subscriptions

Active Mobile Social Users

4.01 1.95 21 7.9 1.5 81.7 410

3.5 1.5 21 2.7 1.4 30 410

3.2 1.3 19 1.8 1.1 28 350

27.66 4.72 49.7 11.28 3.5 137.2 534.4

49.23 39 100.08 35 16.4 3.8 53.3 3.6 0.39 0.34 3.36 0.31 10.11 5.6 34.57 4.9 1.6 1.6 11.46 1.5 0.12 0.12 1.39 0.11 132.7 130 415.7 120 56.7 40 125.87 40 19 19 36.33 17 8.7 5.8 11.34 5.3 14.06 5.8 26.39 2.5 43.33 7.7 39.88 7 1.52 1.1 1.94 0.91 4.1 4.1 7.4 3.1 2.11 1.3 7.91 0.65 5.54 4 4.56 3.6 3.8 3.8 10.94 3.5 25.08 24 42.25 22 340 340 829.9 320 12.4 1.7 20.78 1.5 0.81 0.67 5.07 0.61 107.9 thousand 81 thousand 236.6 thousand 71 thousand 22.56 16 42.35 15 0.95 0.48 9.47 0.44 3.31 2.6 7.07 2 44.6 35 147.5 32 3.05 1.6 3.78 1.4 2.64 2.64 4.67 2.3 30.25 25 56.8 18 9.74 3.1 15.68 2.9 1.2 1.2 6.11 1.1 11.81 2.8 29.88 2.6 6.03 5.5 14.24 3 0.31 9.69 7.89 7.2 17.26 54.33 51 72.9 1.04 0.03 2.98 9.38 9.38 19.18 15.45 1.3 22.65 7.03 2.3 18.37

Source: We are Social, Digital Yearbook, 2018.

91

H ussain M ohi - ud - D in Q adri

using beauty to sell. Using beauty to sell refers to using communication strategies with top models who represent the standard of beauty. However, in the Muslim world, it can be dangerous to be too beautiful or handsome as the male model Omar Borkan Al Gala from the UAE can attest when he was denied entry to Saudi Arabia in 2013 because he was too good looking. When the company sells beauty, it aims at helping consumers to be beautiful, so it will sell beauty products. The second option is to sell the physical representation of beauty in the form of dolls, posters, or books. In both cases (selling beauty or beauty products), marketers have to know if there is a universal symbol of beauty, they can use from one country to the other. If the answer is yes, there is a possibility of launching a unique collection of beauty products or a type of doll representing beauty. If not, there should be a variety of collections catering to different types of beauty (self-tanning products on one end and whitening products on the other for instance) and different types of dolls for each and every culture in the world. The Barbie doll used to be a unique symbol of beauty for the entire world,24 but today, the situation is different. 7.2.2 Beauty products Beauty products are divided into three categories: perfumes, skincare products, and make-up products. When it comes to perfumes, we have problems associated with ingredients, the first being alcohol and the second being animal-derived ingredients (musk or ambergris for instance). For many perfumes, especially luxury perfumes, the formula is top secret. This is the most important asset of a perfume company along with its brand value. There is a widespread assumption that perfume companies protect their formula from their competitors. But the reality is, brands are protecting their brand name, packaging, and logos, and not the formula itself. As consumers do not know the ingredients of perfumes, there have been many phantasms.

Case study A famous case was that of Chanel N5 when the company Chanel was ‘attacked’ by an NGO called Robin Hood, which was aiming for the preservation of the Amazon forest. Robin Hood had accused Chanel of using a rare sort of wood from the Amazon in its formula for Chanel N 5. The NGO did not want Chanel to disclose the whole formula, but only to say if this sort of wood was part of the ingredients. Chanel’s answer—no comment. Chanel did not want to disclose its formula nor its ingredients.

92

R E L I G I O N , C U LT U R E , A N D I S L A M I C M A R K E T I N G

When it comes to alcohol, all perfumes contain a great amount of alcohol. This is an essential component in perfumes as it helps to preserve the fragrance. In Islam, intoxicants are forbidden and alcohol is considered as an intoxicant so alcohol is prohibited. Many Islamic countries pay close attention to the fruit juices or soft drinks that are on sale in their nations. The usual limit for alcohol content is 0.05% of alcohol because, for many fruit juices, fermentation is a natural process and it is hard to obtain 0% alcohol. That being said, everything above 0.05% would be considered haram in countries such as Kuwait or United Arab Emirates and the sale of these products would be strictly monitored and controlled. So why is a product containing 80% of alcohol on sale in the country? The reason is that this product is not supposed to be consumed. It is for external use just as alcohol is used in medicine for cleaning the instruments and machines. As an additional precaution, companies package their perfumes in spray bottles rather than splash bottles in these countries. While contradictory fatwas on this subject exist, so far, no country has forbidden the sale of perfumes on its territory. Halal shampoos and hair-coloring products are popular because hair has always been considered the main seduction element of a female body and there are countless references on the use of hair to seduce men in the Muslim world. In some countries, especially the Indian subcontinent, men also routinely dye their beards and it is not rare to find elderly men with long beards dyed red, yellow or any other color. Given the importance of hair, some countries have determined what is the right (correct) hairstyle, as in the case of Iran. Moral police from the country have identified some hairstyles for men that are halal. All others are considered to be improper from the Islamic point of view.25 In the domain of beauty products, there is clear domination by Western brands because of the brand appeal and, so far, no new company, either from the Western world or Islamic countries, has succeeded in challenging well-established Western brands. As such, Western brands feel safe and do not intend on launching new (halal) products on the market, both in the luxury (Chanel or Dior) or mass-market segment (L’Oréal or Max Factor for instance). One reason for this is the backlash that might be generated if the general public knows that the brands have launched halal products. Another possibility that could happen is the expectation for the brands to also launch kosher beauty products or Hindu, Buddhist, or Christian beauty products, which does not make sense and would introduce religious segmentation variables in a business that prides itself on being global. While these companies have whitening product lines or self-tanning lines,

93

H ussain M ohi - ud - D in Q adri

they cater to ethnic/racial differentiation but not religious segmentation. That said, these products have a temporary effect, so the experience is constantly renewed and repeat purchases flourish. Some services, such as plastic surgery, deliver a permanent effect. The influence of some female singers in the Arab world has a huge impact on girls and women who would like to emulate them.26 Plastic surgery, of course, is used for face procedures such as lips enhancement and, in the case of Iran, there is a massive demand for nose correction and girls often report that to be married, they must undergo plastic surgery. According to Time magazine, Iran is a Muslim country with the greatest number of plastic surgery operations in one year. At least 1% of the total population in the country (750,000 people) decided to undergo some form of plastic surgery in 2013. The price of a nose correction is US$2,000, while tummy tucks are approximately US$1,200–2,800. A facelift can range from US$1,200 to US$2,400, while a forehead lift can go up to US$ 6,000. The Western standard of beauty is extremely prevalent in Iran and the Arab lands. Even if this ideal does not reflect the Middle East’s ideal type of beauty, Western domination is evident.

7.2.3 Fashion Islam invites its followers to be free from materialistic thinking with assurance from the Prophet Muhammad that Allah does not look at their bodies and faces, but into their hearts. Following this concept, women’s dress in Islam is based on a principle of “modesty”. Webster’s New Universal Unabridged Dictionary defines modesty as the “freedom from exaggeration or excess.” All around the pre-Islamic Mediterranean, modesty was considered as the primary female virtue for an ordered human society.27 Female physical beauty was viewed as an incendiary and corrupting influence that could lead to lawlessness, social disorder, and anarchy. Islam followed this tradition and “invites” Muslim women to wear the hijab (even though there are countries like Iran and Saudi Arabia with strict dress codes). In Arabic, the hijab does not mean “head-covering” or “scarf”. It means “barrier” or “screen.” The following verses of the Qur’an explain the relation between women and the hijab: ْ َ‫صاِرِه َّن َويَ ْح ف‬ ْ ‫ض‬ ‫ظ َن فُ ُروَج هُ َّن َوَل يُ ْب ِدي َن ِزي نَ تَ هُ َّن إِ َّل َما ظَ هَ َر‬ ُ ‫ت يَ ْغ‬ َ ‫ض َن ِم ْن أَْب‬ ِ ‫َوقُ ل لِّ ْل ُم ْؤِم نَا‬ َ َ ْ َ ‫ِم ْن هَ ا‬ ‫مرِه َّن َع لَ ى ُج يُوبِ ِه َّن َوَل يُ ْب ِدي َن ِزي نَ تَ هُ َّن إَِّل لِ بُ ُعولَ تِ ِه َّن أْو آبَ ائِ ِه َّن أْو آبَ اِء‬ ِ ُ ‫ضرْب َن بِ ُخ‬ ِ ْ َ‫ول ي‬ َ َ َ َ َ َ َ َ َ ‫بُ ُعولَ تِ ِه َّن أْو أ ْب نَائِ ِه َّن أْو أ ْب نَاِء بُ ُعولَ تِ ِه َّن أْو إِْخ َوانِ ِه َّن أْو بَ نِ ي إِْخ َوانِ ِه َّن أْو بَ نِ ي أَخ َواتِ ِه َّن أْو نِ َسائِ ِه َّن‬ ْ َ‫فل الَّ ِذي َن لَ ْم ي‬ ِّ ‫يمانُ هُ َّن أَ ِو ال تَّ ابِ ِعي َن َغ ْي ِر أُْولِ ي ا ْ ِلْربَ ِة ِم َن ال ِّرَجا ِل أَِو ال‬ ْ ‫أَْو َما َم لَ َك‬ ‫ظ هَ ُروا‬ ِ ْ‫ط‬ َ ْ َ‫ت أ‬ 94

R E L I G I O N , C U LT U R E , A N D I S L A M I C M A R K E T I N G

َّ ‫ض ِرْب َن بِ أَْرُج لِ ِه َّن لِ يُ ْع لَ َم َما يُ ْخ فِ ي َن ِمن ِزي نَ تِ ِه َّن َوتُ وبُوا إِلَ ى‬ ََ ْ َ‫ت النِّ َساِء َوَل ي‬ ‫ﷲِ َج ِمي ًعا‬ ِ ‫على َع ْوَرا‬ ‫تفلحون‬ َ ُ ِ ْ ُ ‫لعلكم‬ َ ُ ِ ْ ُ ْ ‫أيها‬ ْ ُ َّ َ َ ‫المؤمنون‬ َ ُّ َ And it directs the believing women that they (too) must keep their eyes lowered and guard their chastity, and must not show off their adornments and beautification except that (part of it) which becomes visible itself. And they must keep their veils (and head-coverings) drawn over their chests and breasts (too), and must not display their adornments (to anyone) except to their husbands, or their fathers or the fathers of their husbands, or their sons or the sons of their husbands, or their brothers or the sons of their brothers or the sons of their sisters, or (the women of) their (own faith, the Muslim) women or their female slaves or such male servants as are free from any lust and sexual urge, or the children who (being minor) have (yet) no sense of women’s private parts. (They too are exceptions.) Nor must they (while walking) strike their feet (on the ground in such a manner that ornaments jingle and) thus get revealed and known, which they are keeping hidden (under the command of shari’ah). And turn to Allah all of you in repentance, O believers, so that you may prosper (by implementing these commandments).28 In another verse, the Qur’an insists on modesty aimed at protecting women from being bothered: ‫ك أَْدنَى أَن‬ َ ِ‫ك َونِ َساِء اْل ُم ْؤِم نِ ي َن يُ ْدنِ ي َن َع لَ ْي ِه َّن ِمن َج َلبِ ي بِ ِه َّن َذل‬ َ ِ‫ك َوبَ نَا ت‬ َ ‫يَ ا أَيُّ هَ ا ال نَّ بِ ُّي قُ ل ِّلَْزَواِج‬ َّ ْ ُ َ َ ْ َ َ َ ْ ْ َّ ‫رحيما‬ ‫ا‬ ‫ر‬ ‫غفو‬ ‫ﷲ‬ ‫وكان‬ ‫يؤذين‬ ‫فل‬ ‫يعرفن‬ ُ ُ ً َ َ َ ُ َ ِ ً َ O Prophet! Say to your wives, your daughters and the women of believers that (while going out) they should draw their veils as coverings over them. It is more likely that this way they may be recognized (as pious, free women) and may not be hurt (considered by mistake as roving slave girls). And Allah is Most Forgiving, Ever-Merciful.29 The idea of modesty emphasized in this verse encompasses all aspects of life and calls for decency, humility, and moderation in speech, attitude, dress, and total behavior. It is also a tool preventing women from being molested or harassed by men.30 However, one point is not clear: what is beauty and who defines it. The reference to ornaments seems clear, but not for beauty itself.

Case study As Turkey is a secular Republic, the legislation in the country does not define what modesty is from a religious point of view. Instead, it prefers to focus on discrimination and decency. The sensitive approach to the issue of decency in advertising has led to various advertisement

95

H ussain M ohi - ud - D in Q adri

prohibitions and restrictions by the Turkish Advertisement Board. The very existence of these prohibitions shows that the decency and protection of consumers are considered to be more important than creativity and marketing in Turkey. The basic legal requirements for advertisements in Turkey are regulated by the Act on Establishment and Broadcasting of Radio and Television; the Regulation on Fundamentals and Procedures of Broadcasts of Radio and Television Establishments; and the Regulation on the Principles and Fundamentals of Practices Regarding the Commercial Advertisements and Announcements and the Consumer Protection Law. In line with the Consumer Protection Law numbered 4077, advertisements shall be in compliance with the applicable laws and the general principles as determined by the Advertisement Board, general ethics, public order, individual rights, and good faith principle, and the advertisements shall also not be contrary to the national and moral values of the public and Turkish family structure. Among the elements of the Law relative to modesty and religion, we found that advertisements shall not be based on discrimination related to religion, language, race, creed, philosophical opinion, and sex, and they shall not be abusing of the above-cited values. The advertisements should definitely not contain statements or scenes abusing sexuality and shall not contain pornographic scenes either. The advertisements shall not abuse public fears and superstitious beliefs.31 Where fashion is concerned, the Advertisement Board banned Pepsi Cola in Turkey in 2008 because of a campaign announcement in its website that said, “Photos of participants with turbans will not be accepted”. The Advertisement Board ruled that such an announcement causes discrimination and damages the personality rights of those with turbans because of their religious beliefs. The board also said in a statement that the rejection of pictures with women wearing headscarves was a violation of personal rights and promoted discrimination, and fined the company based on a law on the protection of consumer rights. In another case, the Advertisement Board penalized a health institution because its advertisements emphasized that its gynecology department is composed of women doctors only and that patients can feel comfortable. This was viewed as a form of gender discrimination.32 The marketing aspect of the hijab addresses all P’s of marketing. As for the product, it is important for marketers to know to what extent they can introduce new concepts and brands without triggering rejection from consumers and/or their environment. Besides resistance to change, the existence of distribution channels and networks and relative freedom of communication are of the utmost importance.

96

R E L I G I O N , C U LT U R E , A N D I S L A M I C M A R K E T I N G

7.3 Individualism vs collectivism As far as the first dimension is concerned (individualism vs collectivism— IDV), Hofstede (2011) considers that Individualism is the degree of interdependence a society maintains among its members. It has to do with whether people’s self-image is defined in terms of “I” or “We”. In individualistic societies, people are supposed to look after themselves and their direct family only, so the synonym of success would be individual or core family success. In collectivistic societies, people belong to ‘groups’ that take care of them in exchange for their loyalty and, in this case, collective success or happiness is more important than that of an individual. Islam is often identified as being a collectivistic religion because of the importance of the ‘Ummah’ that the Muslim community and all Muslims identify with and because Islam strives for social and economic justice among its members.33 This is why there is compulsory zakat (almsgiving) to help the less fortunate and a strict avoidance of ribā (interest rate or usury rate), which is conducive to social injustice. Loyalty in a collectivistic culture is paramount and overrides most other societal rules and regulations. This loyalty is directed towards persons in socially authoritative positions and religious leaders can play this role. In the case of Shia Islam, it is easier as a certain hierarchy exists. The same can be said of Sunni Islam, where an imam (worship leader), qaḍi (judge), ustaz (scholar), or hafiz (person who has completely memorized the Qur’an), usually enjoys a strong reputation and followers. These individuals can be prescribers for products and services, especially when they issue a fatwa. While a fatwa is an opinion, the followers regard it more like an injunction. A society fosters strong relationships where everyone takes responsibility for fellow members of their group and the responsibility can be individual or collectivistic. Responsibility in dealing with ethical issues is not a new phenomenon in the Western world even if it not easy to analyze all Western countries and cultures and all business issues linked with ethical considerations.34 This has been long debated by the corporate world, especially in Christian Corporate Culture.35 In Islam, the debate on individual and collective responsibility often refers to the Day of Judgment.36 On this day, Muslims will be held individually accountable for all their acts and get rewarded or punished. Their success in the hereafter depends on their performance of life on Earth. In this case, collective responsibility does not exist and the society should be individualistic as there is no intercession between believers and Allah. 97

H ussain M ohi - ud - D in Q adri

Muslims believe that everything on Earth has been created by Allah, and men do not possess anything, especially Nature. They only have stewardship (viceregency—khilafa) responsibility, which is a collective one. In that sense, either through their family or their company’s Corporate Social Responsibility (CSR) program, they must behave as members of the ummah and not just as individuals. The debate about individual (personal) responsibility and collective responsibility will definitely have an influence on corporate social responsibility in Islam, especially with some Islamic countries pushing to make CSR mandatory.37 If it is mandatory for all economic units in a given country, as it has been in Indonesia since 2007, and if the law defines the duty bearer and beneficiaries, there is no room for individual responsibility, which theoretically should be the most important.38 Making CSR mandatory may be a good thing but it is not the panacea. What can happen as with all mandatory rules is the appearance of corruption on one end and cosmetic measures without real impact on the environment on the other end, as is the case in Bangladesh.39 The only way to escape an unfavorable environment for CSR from widespread corruption, inefficient government organizations and supervision and inexistence of civil society pressure is for companies to organize themselves and link CSR to corporate governance rules.40 In this case, it will be a voluntary decision by the company rather than a consequence of mandatory rules imposed by the government. Again, the basic point of responsibility is final accountability during the Day of Judgment. To prepare for it, moral decisions on right and wrong take precedence over economic decisions (cost-effective, profitable operation).41 CSR will refer to the concept of khalifa (vice-regency), where the individual is regarded as the trustee for God’s resources.42 Although private ownership is recognized in Islam, ownership is not absolute, so the ‘owners’ cannot dispose ‘absolutely’ of their possessions, especially when it comes to nature and environmental possessions. Islam has a clearer stance on natural possessions and the depletion of natural resources compared with social responsibility by corporations and individuals.43 With the growing concern on corporate governance, CSR has become a hot issue in the Muslim world. In response, the Islamic Reporting Initiative was set up with the aim of creating a mainstream reporting standard for CSR based on Islamic principles.44 As an example, the company Tetra Pak in Albania emphasizes the importance of milk carton boxes, a recyclable material. Theoretically, Muslims, as individually responsible persons, should take care of the environment and its sustainable development and not need external stimulus from the state to do it. According to this theory, Islamic countries should show high individualistic scores. However, comparing a Western country (Canada) to two Islamic countries (Cameroon and Tunisia), Spence, Ben Boubaker Gherib, and Ondoua Biwole discovered that entrepreneurs in Canada do not require external stimulus 98

R E L I G I O N , C U LT U R E , A N D I S L A M I C M A R K E T I N G

(usually coming from the state), while the opposite is true for Tunisia and Cameroon.45 In collectivistic societies, offense leads to shame and the loss of face; employer/employee relationships are perceived in moral terms (like a family link); hiring and promotion decisions take into account the employee’s ingroup, and management is the management of groups. Belonging to a group can be rather complex in Islam as, in some cases, the group can be a family (sometimes an extended family with thousands of people), a tribe (still very important in some Arab lands and in Africa), fis (kin loyalty in Albania), or a clan (as in Asia). From the Western point of view, the definitions of a tribe and clan do not seem clear but to those belonging to a tribe or a competing tribe, the difference is crystal clear.

Case study One account from Saudi Arabia talks about the Rashidi tribe, a onetime opponent to the Saudi family for the leadership of the country. In his book, the author describes the nature of the tribe and the close links between the nomads and settled groups.46 Another line of collective belonging might be associated with a branch or sect in Islam. Being a sunni or shia definitely separates two collectives. The same can be said for membership in one Sufi brotherhood over another in Senegal. Even if Islam aims to establish a broad community Ummah and, more precisely, destroy clan or kinship allegiance, separate groups still exist in Islam. But attempts are being made to overcome this situation, especially in sub-Saharan Africa where the madrasa teaches in Arabic to overcome social divisions brought about by ancestral ties and ethnicity.47

Case study Associations representing Muslims in the USA such as Council on American-Islamic Relations (CAIR) insist on the inclusive character of Islam and present the diversity of Islam in the country. After 11 September 2001, CAIR launched a campaign in the USA that showed a White person, a Hispanic and an Afro-American. It asked a rhetoric question: ‘We are all Americans, but which one of us is a Muslim?’ The answer was: ‘We all are!’ The campaign was meant to address some stereotypes identifying Islam with just one ethnicity. In the aftermath of September 11, a series of campaigns have been launched in the USA

99

H ussain M ohi - ud - D in Q adri

with the aim of fostering American diversity and Muslim identity and avoiding stereotypes and discrimination.48 In the country, the problem of the representation of Islam and identification with one ethnicity or race such as ‘Islam equals Arabs’ is strong. This is because Muslim immigration is a recent phenomenon and the number of converts is small. The contrary is true in some European lands. Muslims in the Balkan area, for instance, form the majority of the local population, while Turks (who brought Islam to the Balkans) represent a very small minority. An analogy can be drawn with Spain, and especially Andalusia, where there is a debate on who should represent and be the face of Islam: converts (some of whom can identify with conversion as early as the conquest of Spain) or are new immigrants coming mainly from Morocco?49 These two Muslim populations have different socio-economic status and aspirations that will have a deep impact on consumer behavior.

7.4 Ethical edges for marketers in the digital era The digital shift occurred in every field of life with the emergence of the World Wide Web and also by the launching of social media sites, such as Twitter, LinkedIn, Facebook, and so on. Digital interaction via digital channels is a kind of digital presence of people around the globe that can be traced through online social media and many online platforms.50 People are present on different digital platforms at one time, such as a person has a Facebook page, LinkedIn profile, YouTube Channel, Instagram account, twitter account, and many more. The advanced innovations brought about by the fourth industrial revolution, from medical science (biotechnology) to artificial intelligence, machine learning, and robotics, are enumerating what it means to be a human being. They are affecting and leaving an impact on human life span, capabilities, and cognition in means and ways that were previously limited to science fiction discussions and movies. As knowledge and discoveries in these fields progress, our focus and commitment to have ongoing moral and ethical discussions is critical. Companies are testing new technologies to predict the desires and wants of the customers before developing and launching a new product.51 Consider the possibility of machines thinking ahead of us or even out-thinking us. Amazon and Netflix already possess algorithms that predict which films and books we may wish to watch and read. Marketers often spend a lot of time, resources, and energy in collecting customer data as it is a well-known concept that using customer data is a better way to increase returns; hence the company can gain a competitive edge. In the digital age, firms collect data of targeted customers at a mass 100

R E L I G I O N , C U LT U R E , A N D I S L A M I C M A R K E T I N G

level from digital platforms and they spend millions of dollars to leverage that data. Indeed, data collection also has dark sides when the chances of a likely manipulation of a customer’s data vulnerability increase. At this tipping point, marketers have to adopt a value-based tempered approach to manage customers’ data and analytics.52 A recent research53 by American Marketing Association, AMA, reveals that customers often express negative perceptions when the firms get access to their personal data. Their research also highlights four types of vulnerabilities that raise major ethical concerns for firms. • • • •

Data access vulnerabilities: the firm has access to the customer’s personal data, Data breach vulnerabilities: the firm suffers a data breach, Spillover vulnerabilities: a firm’s close rival suffers a data breach, Data manifest vulnerabilities: a data breach allows customer data to be misused, such as for identity theft.

In each of these four vulnerabilities, the customers’ personal data is at threat hence their identity as well. Firms have to take care of customers’ privacy. Marketers need to stop the dissemination of negative words of mouth and sharing of their customers’ data. They have to follow the best Islamic marketing principles, ethical norms, transparency, and control of collected data.

7.5 Summary of the chapter Religion and culture are important factors in formulating any robust marketing strategy. For Muslim consumers, their religion, Islam, and culture have a great value and play a critical role in decision-making. Islamic marketing is based on Islamic principles of marketing and Islamic marketers have to formulate their marketing approach that complies with those principles. By understanding the dynamics of religion and culture in the Islamic marketing mix, companies can attract and persuade more customers. Digital marketers also have to follow Islamic marketing principles and ethical norms in digital marketing.

Notes 1 Casidy, R., Phau, I., & Lwin, M. (2016). The role of religious leaders on digital piracy attitude and intention. Journal of Retailing and Consumer Services, 32, 244–252. 2 Lindridge, A. (2005). Religiosity and the construction of a cultural-consumption identity. Journal of Consumer Marketing, 22(3), 142–151. 3 Delener, N. (1994). Religious contrasts in consumer decision behavior patterns: Their dimensions and marketing implications. European Journal of Marketing, 28(5), 36–53.

101

H US SA I N MOH I-U D -DI N QA DR I

4 Brian, T., & Peter, W. (1996). Global Marketing Management: A Strategic Perspective, 2nd edition, p. 251. 5 Leviticus 25:14. 6 Lapin, R. D. (2014). Business Secrets from the Bible: Spiritual Success Strategies for Financial Abundance. Wiley Publications, 45–48. 7 Choudhury, K. (2019). Materialism, consumerism, and religion: A Buddhist vision for nonprofit marketing. International Journal of Nonprofit and Voluntary Sector Marketing, e1634. 8 Abeysekera, N., Hewawasam, B., & Chandrasekar, K. S. (2012). Relationship between Marketing & Buddhism-An Analysis of Eightfold Path. 9 Al-Hyari, K., Alnsour, M., Al-Weshah, G., & Haffar, M. (2012). Religious beliefs and consumer behaviour: From loyalty to boycotts. Journal of Islamic Marketing, 3(2), 155–174. 10 Narrated by al-Bayhaqī in al-Sunan al-kubrā,10:191 §20571. 11 Narrated by al-Tirmidhī in al-Sunan: Bk.: Faith according to Allah’s Messenger (Allah bless him and give him peace), Ch.: What has come to us concerning the perfecting of faith, its increase and its diminution, 5:9 §2612. 12 Narrated by al-Bukhārī in al-Ṣaḥīḥ: Bk.: Bad’ al-Waḥy [The Beginning of Inspiration], Ch.: How inspiration began, 1:3 §3. 13 Qur’ān 33:21. 14 Ahmad, N. (2018). Toward advancing debates on Islamic marketing: A renewed perspective. Journal of Islamic Marketing, 9(1), 152–166. 15 Narrated by Abū Dāwūd in al-Sunan: Bk.: al-Adab [Proper Conduct], Ch.: Regarding good interaction with people 4:251 §4790. 16 Qadri, H. M.-D. (2019). Business Ethics in Islam. Taylor & Francis. 17 Abdulrahim, A., Iba Der, T., & Yusof, A. T. (2016). The Different Aspects of Islamic Culture: Islam in the World Today; Retrospective of the Evolution of Islam and the Muslim World. UNESCO Publishing. 18 Resources, M. A., Information. (2014). Marketing and Consumer Behavior: Concepts, Methodologies, Tools, and Applications: Concepts, Methodologies, Tools, and Applications. IGI Global. 19 Nestorović, Č. (2016). Islamic Marketing: Understanding the Socio-Economic, Cultural, and Politico-Legal Environment. Springer. 20 Sandikci, O., & Ger, G. (2009). Islam and Consumption: Beyond Essentialism. ACR North American Advances, 36, 210–213. 21 Peukert, C. (2019). The next wave of digital technological change and the cultural industries. Journal of Cultural Economics, 43(2), 189–210. 22 Nestorović, Č. (2016). Islamic Marketing: Understanding the Socio-Economic, Cultural, and Politico-Legal Environment. Springer. 23 Lynch, G., Mitchell, J., & Strhan, A. (2012). Religion, Media and Culture: A Reader. Routledge. 24 Jones, G. (2008). Blonde and blue-eyed? Globalizing beauty, c. 1945–c. 1980 1. The Economic History Review, 61(1), 125–154. 25 Effendi, R. (2010). Young in Tehran. World Policy Journal, 27(4), 74–85. 26 Doherty, S. B. (2008). Cosmetic surgery and the beauty regime in Lebanon. Middle East Report, (249), 28–31. 27 Alshech, E. (2007). Out of sight and therefore out of mind: Early Sunnī Islamic modesty regulations and the creation of spheres of privacy. Journal of Near Eastern Studies, 66(4), 267–290. 28 Qur’ān 24:31. 29 Qur’ān 33:59.

102

R E L I G I O N , C U LT U R E , A N D I S L A M I C M A R K E T I N G

30 Boulanouar, A. W. (2006). The notion of modesty in Muslim women’s clothing: An Islamic point of view. New Zealand Journal of Asian Studies, 8(2), 134. 31 http://www.wipo.int/wipolex/en/ details.jsp?id¼10735. 32 http://en.hukuki.net/index.php?topic¼70.0;wap2. 33 Junisbai, A. K. (2010). Understanding economic justice attitudes in two countries: Kazakhstan and Kyrgyzstan. Social Forces, 88(4), 1677–1702. 34 Schlegelmilch, B. B. (1997). Marketing Ethics: An International Perspective. Cengage Learning EMEA. 1st edition (December 18, 1997) 35 Demuijnck, G. (2009). From an implicit Christian corporate culture to a structured conception of corporate ethical responsibility in a retail company: A case-study in hermeneutic ethics. Journal of Business Ethics, 84(3), 387. 36 Smith, J. I., & Haddad, Y. Y. (2002). The Islamic Understanding of Death and Resurrection. Oxford University Press. 37 Williams, G., & Zinkin, J. (2010). Islam and CSR: A study of the compatibility between the tenets of Islam and the UN Global Compact. Journal of Business Ethics, 91(4), 519–533. 38 Waagstein, P. R. (2011). The mandatory corporate social responsibility in Indonesia: Problems and implications. Journal of Business Ethics, 98(3), 455–466. 39 Belal, A. R., & Roberts, R. W. (2010). Stakeholders’ perceptions of corporate social reporting in Bangladesh. Journal of Business Ethics, 97(2), 311–324. 40 Rahim, M. M., & Alam, S. (2014). Convergence of corporate social responsibility and corporate governance in weak economies: The case of Bangladesh. Journal of Business Ethics, 121(4), 607–620. 41 Kuran, T. (1996). The discontents of Islamic economic morality. The American Economic Review, 86(2), 438–442. 42 Wilson, R. (2006). Islam and business. Thunderbird International Business Review, 48(1), 109–123. 43 Rice, G. (2006). Pro-environmental behavior in Egypt: Is there a role for Islamic environmental ethics? Journal of Business Ethics, 65(4), 373–390. 44 www.Islamicreporting.org. 45 Spence, M., Gherib, J. B. B., & Biwolé, V. O. (2011). Sustainable entrepreneurship: is entrepreneurial will enough? A north–south comparison. Journal of Business Ethics, 99(3), 335–367. 46 Al-Rasheed, M. (1997). Politics in an Arabian Oasis: The Rashidi Tribal Dynasty. IB Tauris. 47 LeBlanc, M. N. (1999). The production of Islamic identities through knowledge claims in Bouaké, Côte d’Ivoire. African Affairs, 98(393), 485–508. 48 Alsultany, E. (2007). Selling American diversity and Muslim American identity through nonprofit advertising post-9/11. American Quarterly, 59(3), 593–622. 49 Rogozen-Soltar, M. (2012). Managing muslim visibility: Conversion, immigration, and Spanish imaginaries of Islam. American Anthropologist, 114(4), 611–623. 50 Chaffey, D., & Ellis-Chadwick, F. (2019). Digital Marketing. Pearson. 51 Stephen, A. T. (2016). The role of digital and social media marketing in consumer behavior. Current Opinion in Psychology, 10, 17–21. 52 Oliver, M. A., & Vayre, J.-S. (2015). Big data and the future of knowledge production in marketing research: Ethics, digital traces, and abductive reasoning. Journal of Marketing Analytics, 3(1), 5–13. 53 American Marketing Association. (2016). https://www.ama.org/topics/ethics/.

103

H ussain M ohi - ud - D in Q adri

References Abdulrahim, A., Iba Der, T., & Yusof, A. T. (2016). The Different Aspects of Islamic Culture: Islam in the World Today; Retrospective of the Evolution of Islam and the Muslim World. Beirut: UNESCO Publishing. Abeysekera, N., Hewawasam, B., & Chandrasekar, K. S. (2012). Relationship between Marketing & Buddhism-An Analysis of Eightfold Path. Srusti Management Review, 5(1), 113–116. Abū Dāwūd, Sulaymān b. Ash’ath b. Isḥāq b. Bashīr al-Sijistānī (202–275/817–889). (1414/1994). Al-Sunan. Beirut: Dār al-Fikr. Ahmad, N. (2018). Toward advancing debates on Islamic marketing: A renewed perspective. Journal of Islamic Marketing, 9(1), 152–166. Al-Hyari, K., Alnsour, M., Al-Weshah, G., & Haffar, M. (2012). Religious beliefs and consumer behaviour: From loyalty to boycotts. Journal of Islamic Marketing, 3(2), 155–174. Al-Rasheed, M. (1997). Politics in an Arabian Oasis: The Rashidi Tribal Dynasty. London: IB Tauris. Alshech, E. (2007). Out of sight and therefore out of mind: Early Sunnī Islamic modesty regulations and the creation of spheres of privacy. Journal of Near Eastern Studies, 66(4), 267–290. Alsultany, E. (2007). Selling American diversity and Muslim American identity through nonprofit advertising post-9/11. American Quarterly, 59(3), 593–622. American Marketing Association. (2016). https://www.ama.org/topics/ethics/. Bayhaqī, Aḥmad b. al-ḥusayn al-. (1994). Al-Sunan al-kubrā. Mecca: Maktaba Dār al-Bāz. Belal, A. R., & Roberts, R. W. (2010). Stakeholders’ perceptions of corporate social reporting in Bangladesh. Journal of Business Ethics, 97(2), 311–324. Boulanouar, A. W. (2006). The notion of modesty in Muslim women’s clothing: An Islamic point of view. New Zealand Journal of Asian Studies, 8(2), 134. Brian, T., & Peter, W. (1996). Global Marketing Management: A Strategic Perspective. 2nd edition, Boston, MA: Allyn & Bacon, p. 251. Bukhārī, Abū’Abd Allāh Muhammad b. Ismā’īl b. Ibrahīm b. Mughīra al-. (194–256/810–870). (1401/1981). Al-Ṣaḥīḥ. Beirut and Damascus: Dār al-Qalam. Casidy, R., Phau, I., & Lwin, M. (2016). The role of religious leaders on digital piracy attitude and intention. Journal of Retailing and Consumer Services, 32, 244–252. Chaffey, D., & Ellis-Chadwick, F. (2019). Digital Marketing. London: Pearson. Choudhury, K. (2019). Materialism, consumerism, and religion: A Buddhist vision for nonprofit marketing. International Journal of Nonprofit and Voluntary Sector Marketing, 24(3), 1–7, e1634. Demuijnck, G. (2009). From an implicit Christian corporate culture to a structured conception of corporate ethical responsibility in a retail company: A case-study in hermeneutic ethics. Journal of Business Ethics, 84(3), 387. Delener, N. (1994). Religious contrasts in consumer decision behavior patterns: Their dimensions and marketing implications. European Journal of Marketing, 28(5), 36–53 Doherty, S. B. (2008). Cosmetic surgery and the beauty regime in Lebanon. Middle East Report, (249), 28–31.

104

R E L I G I O N , C U LT U R E , A N D I S L A M I C M A R K E T I N G

Effendi, R. (2010). Young in Tehran. World Policy Journal, 27(4), 74–85. Hofstede, G. (2011). Dimensionalizing cultures: The Hofstede model in context. Online Readings in Psychology and Culture, 2(1), 2307–0919. http://en.hukuki.net/index.php?topic¼70.0; wap2. http://www.wipo.int/wipolex/en/ details.jsp? id¼10735. Jones, G. (2008). Blonde and blue-eyed? Globalizing beauty, c. 1945–c. 1980 1. The Economic History Review, 61(1), 125–154. Junisbai, A. K. (2010). Understanding economic justice attitudes in two countries: Kazakhstan and Kyrgyzstan. Social Forces, 88(4), 1677–1702. Kuran, T. (1996). The discontents of Islamic economic morality. The American Economic Review, 86(2), 438–442. Lapin, R. D. (2014). Business Secrets from the Bible: Spiritual Success Strategies for Financial Abundance. Hoboken, NJ: Wiley Publications, 45–48. LeBlanc, M. N. (1999). The production of Islamic identities through knowledge claims in Bouaké, Côte d’Ivoire. African Affairs, 98(393), 485–508. Leviticus 25:14. Lindridge, A. (2005). Religiosity and the construction of a cultural-consumption identity. Journal of Consumer Marketing, 22(3), 142–151. Lynch, G., Mitchell, J., & Strhan, A. (2012). Religion, Media and Culture: A Reader. London: Routledge. Nestorović, Č. (2016). Islamic Marketing: Understanding the Socio-Economic, Cultural, and Politico-Legal Environment. Cham: Springer. Oliver, M. A., & Vayre, J.-S. (2015). Big data and the future of knowledge production in marketing research: Ethics, digital traces, and abductive reasoning. Journal of Marketing Analytics, 3(1), 5–13. Peukert, C. (2019). The next wave of digital technological change and the cultural industries. Journal of Cultural Economics, 43(2), 189–210. Qadri, H. M.-D. (2019). Business Ethics in Islam. London: Taylor & Francis. Rahim, M. M., & Alam, S. (2014). Convergence of corporate social responsibility and corporate governance in weak economies: The case of Bangladesh. Journal of Business Ethics, 121(4), 607–620. Resources, M. A., Information. (2014). Marketing and Consumer Behavior: Concepts, Methodologies, Tools, and Applications: Concepts, Methodologies, Tools, and Applications. Hershey, PA: IGI Global. Rice, G. (2006). Pro-environmental behavior in Egypt: Is there a role for Islamic environmental ethics? Journal of Business Ethics, 65(4), 373–390. Rogozen-Soltar, M. (2012). Managing muslim visibility: Conversion, immigration, and Spanish imaginaries of Islam. American Anthropologist, 114(4), 611–623. Sandikci, O., & Ger, G. (2009). Islam and consumption: Beyond essentialism. ACR North American Advances., 36, 210–213. Schlegelmilch, B. B. (1998). Marketing ethics: An international perspective. Cengage Learning EMEA, 31, 308–314. Smith, J. I., & Haddad, Y. Y. (2002). The Islamic Understanding of Death and Resurrection. New York: Oxford University Press. Spence, M., Gherib, J. B. B., & Biwolé, V. O. (2011). Sustainable Entrepreneurship: Is Entrepreneurial will enough? A north-south Comparison. Journal of Business Ethics, 99(3), 335–367.

105

H ussain M ohi - ud - D in Q adri

Stephen, A. T. (2016). The role of digital and social media marketing in consumer behavior. Current Opinion in Psychology, 10, 17–21. Tirmidhī, Abū’Īsā Muhammad b. ‘Īsā al-. (2004). Al-Sunan. Beruit: Dār Iḥyā’ alTurāth al-’Arabī. Waagstein, P. R. (2011). The mandatory corporate social responsibility in Indonesia: Problems and implications. Journal of Business Ethics, 98(3), 455–466. Williams, G., & Zinkin, J. (2010). Islam and CSR: A study of the compatibility between the tenets of Islam and the UN global compact. Journal of Business Ethics, 91(4), 519–533. Wilson, R. (2006). Islam and business. Thunderbird International Business Review, 48(1), 109–123. www.Islamicreporting.org.

106

8 A THEORETICAL MODEL FOR JOB CREATION The role of banks Anwar Shah 8.1 Introduction Unemployment is one of the major problems in developing countries. The International Labour Organization’s definition of unemployment covers people who are: out of work, want a job, have actively sought work in the previous four weeks, and are available to start work within the next fortnight; or out of work and have accepted a job that they are waiting to start in the next fortnight. Unemployment is measured annually as a percentage of that labour force that cannot find a job. According to neoclassical economics, unemployment occurs when rigidities are imposed on the labour market from the outside. But according to the Keynesian school of thought, unemployment is due to inbuilt wage rigidities in the labour market and can be addressed through effective demand for goods and services. In the current literature on unemployment, we find various studies that analyse the issue of unemployment from various dimensions. We find studies on youth unemployment (Irfan, 2000; Akhtar & Shahnaz, 2005; Haider, 2010), self-employment (Anwar et al., 2010), foreign direct investment and unemployment (Arslan & Zaman, 2014; Sarwar & Mubarik, 2014), etc. Likewise, we find studies on the status of employment at various stages of Pakistan’s economy (see, for example, Amjad & Naseem, 1992; Ghayur & Burki, 1992). Most of these studies provide a positive analysis of the state of the unemployment in the economy of Pakistan and provide significant contribution for policy makers in terms of identifying the factors leading to and combating unemployment. Some of the recommendations for combating unemployment in the past revolved around financing various sectors/subsectors and full implementation of three D’s namely deregulation, decentralization, and denationalization (Ghayur & Burki, 1992). Likewise Ministry of Labour and Manpower for the Ninth Five Year Plan (1998–2003) suggested measures to promote small-scale industries and self-employment, in particular, industrial support centres at proper locations to provide services to small-scale industries such as material testing, laboratory, etc., provision of DOI: 10.4324/9781003050209-8

107

A nwar S hah

a credit fund for rural industries, establishment of entrepreneurial development institutes for the training of entrepreneurs, promotion of manpower export to relieve the labour supply pressures, and enhancement in training capacity. To cater to the needs of 68% of the total population of Pakistan, who are below the age of 30, the current government, in this regard has devised the National Youth Development Framework (NYDF) on the principles of the 3E’s: Education, Employment and Engagement. Keeping these 3E’s, the government has designed a programme named “Prime Minister’s Kamyab Jawan Programme”. Under this programme, the government has been creating opportunities of socio-economic empowerment for youth (for more details, explore https://kamyabjawan.gov.pk). Nevertheless, the issue of unemployment persists, and according to Labour Force Survey 2017– 2018, the overall unemployment rate is 5.79%, showing an increasing trend in both rural and urban areas in absolute as well as in percentage terms. It is worthwhile to state that as compared with the past, policy makers have limited options to address unemployment because it is neither feasible to generate large-scale employment in the public sector nor possible due to limited budgetary considerations. Hence, most of the responsibility falls on the private sector. This study attempts to present a model for the generation of jobs at the micro level in the services industry. The model has three players: households, banks, and service provider companies. In the model, household receives various home services from the service provider company at market rates. However, payment is not made by the household directly to the service provider company. Rather, the payment is made by banks to the companies on behalf of the household, who open time deposit in the bank. The bank allows payment over and above the available fund on behalf of the household (overdraft), which the household can submit to the bank on a monthly basis later. We assume the model to be efficient, where every player has an incentive to be part of the model. The incentive for the banks is the commission to be deducted from the invoices of the companies. In addition, the bank can ensure monthly instalments by having salaries to be transferred to the account of the household member via the same bank. The company has an incentive of having a higher turnover and immediate cash payment via the bank. The incentive to have home issues solved at competitive prices from registered companies with proper documented guarantee inspires households. In addition, the model offers opportunities of improving employment rates and absorption of skilled people, as behavioural studies show that people demand more goods and services when they are not expected to pay cash upfront as compared with when they have to pay cash (Chien & Devaney, 2001; Hayhoe et al., 1999). Hence, the proposed model is likely to create demand for home services related to various issues such as plumbing, electricity, glass fitting, etc., leading to the creation of jobs for skilled people and their absorption into the market. The model

108

T H E OR ET ICA L MODEL FOR JOB C R E AT ION

will enable the projects under National Vocational and Technical Training commission (NAVTTC) (http://navttc.org/) to be very successful because the focus of the project is on the supply side while there is no provision of how to meet the supply with demand. Regional skill development centres involve the private sector in the field of technical and vocational training. For example, Punjab Vocational Training Council (PVTC) was created in 1998 to impart demand-driven skill training to deserving persons at vocational training institutes in Punjab. According to Irfan (2000), we need to assess and evaluate the precise contribution of private sector involvement in technical and vocational training systems of the country. The study claims that the Centre Management Committees (CMCs) with an objective to manage and guide the technical training centres at the local level apparently met with little success. Either the employer could not make time to attend a meeting in some cases and/or the principal of technical training centre failed to do the necessary homework for fruitful collaboration. The study further laments that Policy makers should re-examine their expectations with respect to technical and vocational education system. Rather than regarding it as a vehicle to promote employment, its appropriate role should be to release the skill constraints in the strategic reallocation of human resources in the economy. Ironically while the economic management accords top priority to private sector, the latter has so far failed to make any solid contribution towards employment generation or in the field of education and training. Whatever participation has been achieved in the field of technical and vocational training can hardly be characterized as a major initiative. p. 39 Irfan (2000) also mentions that informal training under the traditional ustad/shagird (master/student or trainer/trainee) system accounts for majority of the trained workforce in the country. However, precise information regarding contribution of this system towards job creation does not exist due to a lack of availability of data. The focus of our model is on the demand side, which will help the government of Pakistan make projects of vocational training at the federal and provincial level more successful. However, the central government will need to make some changes to the laws related to the banking sector to help common people with an overdraft facility to pay for services availed from expert labourers. The rest of the chapter is organized as follows: Section 8.2 deals with the literature review. Section 8.3 discusses the background of our society and the model. Section 8.4 concludes the chapter.

109

A nwar S hah

8.2 Literature review This section provides a brief review of the studies examining unemployment in Pakistan. For example, Akhtar and Shahnaz (2006) explain factors contributing to the unemployment of youth in Pakistan from 1990 to 2003. The study reveals that the youth unemployment fluctuated between 7.6% and 13.6% during 1990–1991 and 2003–2004. The study shows that unemployment of youth decreases if the annual growth rate of GDP is greater than 4.25% per annum. Likewise, the study finds that youth unemployment decreases when the growth in private sector investment is more as compared with the growth in the public sector investment. The study also mentions that the unemployment of females is correlated to the growth of the services sector. Based on the Labour Force Survey of 2003–2004, the study indicates that skill acquisition and vocational training do not increase the chances of employment. This study indicates that the provision of skills might not be enough for the creation of employment until there is an increase in the demand for the services of the people with similar skills. Haider (2010) provides answers to the questions regarding unemployment growth in Pakistan. The study considers the sectoral shift in the economy of Pakistan as one of the causes of increasing unemployment. The study argues that the sectoral shift from agriculture to the services sector led to unemployment growth. In this regard, the study provides evidence from the sectoral reallocation in Pakistan during 1968–1985. Aqil et al. (2014) explore the factors that affect the employment level in Pakistan. The study uses data on the GDP growth rate, inflation, FDI, and population growth rate to understand their relationship with unemployment. The study finds that the GDP growth rate and inflation have no significant relationship with unemployment. However, FDI and the population growth rate have significant negative relationship with unemployment. Likewise, Arslan and Zaman (2014) explore the determinants of unemployment in Pakistan for the period of 1999–2010. The study takes foreign direct investment, gross domestic product rate, CPI-based inflation rate, and population growth rate as explanatory variables. Using the ordinary least squares method, the chapter shows that foreign direct investment, gross domestic product rate, and CPI-based inflation rate have a negative impact on unemployment. In contrast to the finding of Aqil et al. (2014), this study shows a positive relationship of population growth rate with unemployment. In addition, the study confirms the trade-off between inflation and unemployment. Sarwar and Mubarik (2014) test the impact of foreign direct investment in the province of Punjab by using the annual data from 1984 to 2010. By using the ARDL approach, the study finds the existence of cointegration between FDI and employment. Anwar et al. (2010) investigate determinants of self-employment in Pakistan using the data of 494 workers residing in Bahawalpur district. Based 110

T H E OR ET ICA L MODEL FOR JOB C R E AT ION

on logistic regression, the study finds the positive role of experience and age on self-employment. Moreover, educational attainment and good health also have a significant and positive influence on workers’ decision to be self-employed. Most of the above studies analyse data (both primary and secondary) to explore the relationship of unemployment with various factors. Our study is different in the sense that we are not analysing any statistical relationship of different factors with unemployment. Rather, we present a model that is ex ante assumed to be conducive for mitigating the issue of unemployment at a micro level.

8.3 The model This section provides the background and full details of our proposed model. 8.3.1 Background of the model In our society the head of the households is responsible for the affairs of the households. He/she has to fulfil the needs of the household members who have needs other than food and health, as those relating to the maintenance of the household. Hence, every head of the household on average would like to have the small maintenance problems of house solved instantly, so that they may not become a bigger issue over time. However, they have asymmetric information about the know-how of skilled people and their reliability for having such issues resolved. This informational asymmetry has two repercussions. The first is that small household problems remain unresolved. The second repercussion is that this mismatch leads to inefficiency as mutual exchange could have benefited both sides of the market, had it occurred. The existence of unfulfilled issues and tasks at home is likely to become unattended wounds and injuries, which could become serious and fatal over time. For example, if there exists a minor electrical failure, such as unfixed broken switches in a house. However, the household head does not know any relevant person to invite him to fix it. Someone lets him know of such a person, but he does not invite him for fixing this problem, fearing that the skilled person will charge a large amount of money for this petty task.1 However, after some time, the same small issue could become serious leading to short-circuiting or electrocution of a member of the family. Had the household member fixed the problem on time, the issue of electrocution might not have occurred. On the same lines, we can think about many services related to plumbing, glass fitting, sewerage, painting, brick fixing, etc., which the household has demand for, but is not able to complete due to a lack of handy cash and asymmetric information about the presence and reliability of skilled people. 111

A nwar S hah

How to match both supply and demand sides of the market? The solution is intermediation between both. The same has been mentioned by Akhtar and Shahnaz (2006). In the concluding remarks, they mention that Given that the education and skill acquisition profile of unemployed is better than employed youth and specifically of urban unemployed (ignoring the issue of quality differentials), lack of education and skills is not the main impediment to jobs. We would speculate that it is a combination of (a) lack of networking in the job market; (b) expectation of higher wages fuelled by their well-off rural background; and (c) depressed skill specific demand in relation to steady supply of youth with higher skills and higher education levels. For the minimization of jobless growth, Haider (2010) recommends a well-coordinated labour policy based on market driven demand of skills with a focus on targeted areas of economy as leading growth sector can be identified. The areas having greater absorption capacity can lead the path to avoid or minimise jobless growth. A continuous skill enhancement, trainings of labour force, especially involved in traditional sectors of economy, matching with market driven skill demand minimises the fluctuations in employment status hence lessens chances for jobless growth. It is worth mentioning that some intermediation for matching demand with supply prevails in the market; however, it is mostly available on cash payment, which only the rich segment of the society can afford. For example, one can give a call to the office of a service provider, who then, sends someone for the delivery of the required service on cash payment. On average, such arrangement of services is quite expensive as the service provider adds service charges in addition to the market price of the labour charges. This is the reason that such market excludes a large segment of the society, who could not avail the services of such companies due to the non-availability of handy cash. This excluded part of the demand might be included in the market if they are provided the opportunity to offer such services on instalment instead of one-time full cash payment. Our proposed model caters to this need for market service providers with banks as intermediaries. 8.3.2 Details of the model Our model has three players: households in need of different services, service provider companies, and banks. In the model, household (HH) opens a time deposit (savings) account in the bank. The bank provides the overdraft facility to HH from this account. HH can withdraw more than the available 112

T H E OR ET ICA L MODEL FOR JOB C R E AT ION

funds in the account. However, the provision of extra withdrawal of the funds are provided against service demand from the service provider company only. Knowing the facility of withdrawal over and above the available funds, service provider companies will compete with each other in offering their services to HH. And it is possible that the service provider company even visits HH and offers them competitive prices for the various types of services. In addition, they might offer guarantee of their services to HH. Once HH receive services, they will write a crossed cheque to the service provider company, which allows the funds to be transferred from the account of HH to the account of the company. However, the bank will deduct service charges when transferring funds from the account of HH to the account of the company. The bank will not charge any kind of fee from HH for such a transfer. HH will return the payment to banks in instalments, which the bank can deduct on a monthly basis from the salary account of the HH head. For such purpose, it will be necessary that the salary of the HH head is credited to the salary account in the same bank, from which HH is availing the overdraft facility. I am going to elaborate the proposed model through an example. Let us assume the HH head is a teacher and has a salary of PKR50,000 (fifty thousand) per month. The HH head has a salary account in HBL, where his salary is credited. The HH head opens another but savings account with HBL. HH head allows HBL to transfer 10,000 per month from his salary account to the savings account. HBL provides the facility of overdraft of up to PKR1,20,000 (one lakh and twenty thousand). There is only PKR10,000 in the savings account but the HH head acquires services of plumbing and white washing of all bathrooms, which cost about 50,000 (fifty thousand). The HH head writes a crossed cheque for 50,000 to the company against the savings account. HH knows that he has only 10,000 in the account; however, HBL will clear his cheque by transferring 50,000 to the account of the service provider company, after deducting the transfer fee from the company. Here HBL provides an overdraft for PKR40,000 to the HH head. The HH head will clear this amount in the next four months. If the HH head demands any other service from the company before repaying all PKR40,000, still they can avail such service as the limit of the overdraft facility is up to PKR1,20,000. This arrangement has incentives for every player subscribing to the model. The HH head receives services from the company at competitive market prices. In addition, the HH can receive guarantees against the service provision, in which case, the issue of moral hazard due to asymmetric information on the part of company drops, thus benefiting the HH. The incentive to the company is that they receive instant cash for the services. In addition, they receive more orders from the HH, thus multiplying their opportunity of earning more profit. Empirical evidence shows that a person uses more money on credit cards than by paying cash. Once HH does 113

A nwar S hah

not have to pay cash to the company, they will increase orders, thus benefiting both self and the company. The incentive to the bank is that they will earn commission on the transfer of funds to the company. In addition, the number of deposits will multiply, which they can use for earning purposes. Figure 8.1 elaborates on the model in simple terms. In the middle is the service provider company that provides services to the HH and receives the crossed cheque. The company deposits this crossed cheque in the bank, which the bank transfers to its account after deducting the agreed upon commission. The advantage of this model is that the service provider company will provide guarantee to the HH regarding the quality of their services. In case the provided services are unsatisfactory, the HH can ask the company for redoing the job without payment. Hence, each service provider will try their level best to deliver services with honesty; otherwise, they have to re-do the job without payment. Moreover, each service provider can lose their trust in the eyes of people in case they provide low-quality service to the members. Hence, the fear of becoming blacklisted after losing a contract is likely to limit the moral hazard on the part of service providers. Another advantage of the model is that the HH will not hesitate to use the service providers even in the case of minor services as the HH is not supposed to pay instantly after receiving the services. Hence, the demand

Transfer of funds after deduction of commission

Service Provider Company

Services to HH

House Hold

Bank Cross cheque in favor of company, which the company deposit in the bank

Figure 8.1 Graphical presentation of the services delivery model.

114

T H E OR ET ICA L MODEL FOR JOB C R E AT ION

for services will increase. Studies show that people avail services more when they are not supposed to pay instantly, than when they are supposed to pay straightaway. For example, those who hold credit cards buy more than those who do not hold credit cards (Chien & Devaney, 2001; Hayhoe et al., 1999). Even though HHs have to make a deferred payment, they need not worry about the quality of the services. They will receive the same services as one hires privately after proper negotiation. Members have the additional advantage of complaining against overcharging by the service provider, which will constrain them from charging non-competitive prices. The facility of deferred payment for quality services on competitive prices from the service provider company is likely to increase the demand of home services from HHs. This will, in turn provide opportunity to the service provider company to hire services of more skilled individuals. Hence, the demand for skilled individuals will increase in the market. In case the available supply does not meet the demand, the company can arrange a contract with a vocational and technical training institute to impart training to new students. The company can pay all charges for these new students and seek financing from the government or donor agencies. It is also possible that the service provider company will bear the total cost of training students, who after becoming part of the market can reimburse the cost of such training in instalments. Hence, this model has the flexibility regarding how to increase the opportunities of employment for youth and then absorb them into the market without any financial burden on them ex ante. The model can also be extended for the provision of services outside home, such as medical services, vehicle maintenance, accidental repairs, etc. The only limitation of the model is that the overdraft facility cannot be provided to those who are not account holders of banks. However, this limitation will dwindle as soon as the ratio of documentation multiplies in the economy. 8.3.3 Comparison of the proposed model with the current models of jobs creation Job creation is a macro issue in conventional economic theories. Various schools of thought differ in their explanation regarding the cause of unemployment. For example, neoclassical economics postulates that the labour market is efficient if left alone and various interventions, such as minimum wage laws and unionization, put supply and demand out of balance, leading to unemployment. In other words, free markets of labour are always in equilibrium and unemployment in the economy is a temporary issue. However, Keynesians are of the view that markets fail in achieving full employment as the assumptions of the classical school of thought rarely prevail in labour markets. The Keynesian school of thought proposes that a “natural rate” of unemployment always prevails because the skills of labourers and the positions available are slightly out of equilibrium even under the best 115

A nwar S hah

economic conditions. Hence, most of the debate regarding employment revolves around the Keynesian school of thought. They consider the demand in the market as a key factor for employment and consider the government is responsible for the creation of such demands. Hence, aggregate demand in the economy is mainly considered a job-creating factor. However, the limitation of this approach is that the signals from growth towards job creation might be misleading, because growth in conventional economies might be based on growth in nominal sectors instead of real sectors. Growth in nominal sectors is like bubbles that might burst any time similar to that of the 2008 financial crisis. However, individuals are unable to perceive the bubbles and profit-maximizing firms might produce jobs in the sector, which are likely to burst soon. Hence, such job creation might not be persistent in the market. Another aspect of this model is that everyone bears the expenses of job training and the poor might not be able to bear such expenses. If the poor receive loans for gaining skills, they might not be able to retire the loan when the market is unable to absorb them. In addition, the conventional system of loans extension to the poor for self-employment on average fails. The reason is that poor youth have no collateral nor are they able to bear the high interest rate on loans. For example, Grameen Bank (GB), which has as of October 2011, 8.349 million borrowers, 97% of whom are women, charges 20% interest (Fernando, 2006). Likewise, the Small Business Finance Corporation (SBFC) was set up in 1972 with the objective of developing and promoting small business enterprises and small-scale industries, but the objectives are still unmet. In the same way, loan facilities of many micro-finance institutions at private and public sectors help the poor less than the rich. Moreover, the loan facility for self-employment on the basis of interest is completely against the tenets of Islam and creates many socio-economic problems for the poor. Our model caters to these issues in an efficient way and provides simple and purely demand-driven opportunities that create jobs.

8.4 Conclusion Unemployment is a major issue for all countries and has attracted the attention of many researchers and scholars. We find work on unemployment from various dimensions in the context of Pakistan. However, the main focus has been on the conventional model of growth-led employment. We also find studies that examine the issue of unemployment from a micro perspective, but such studies are confined to empirical analysis. The current study is an attempt to present a model of job creation in the service sector while taking into account the cultural and behavioural rigidity of our economy. The chapter argues that if we manage to involve banks by offering the facility of overdraft, we can create demands in home services, leading to job 116

T H E OR ET ICA L MODEL FOR JOB C R E AT ION

creation for the skilled yet unemployed people in an economy. Each household can ask the services company for offering home services. The company, by making contracts with skilled individuals, can serve households in need of their services. The role of banks is intermediary between a household and service provider company. The bank pays to the service provider company on behalf of the HH, while the HH gives a crossed cheque to the service provider company. When the demand for home services increases over time, the demand for skilled individuals in the market is likely to rise too. Hence, the company can make new contracts or arrange for the training of new students. The model is likely to be better than the other model of job creation at the micro level in the market. The current models, mostly, either focus on training new people without arranging for their absorption in the market or offering them employment or, in particular youth, interest-based loans for self-employment. On the other hand, in our model, households are likely to be comprising those who are relatively wealthy, while service providers are likely to be those segments of the society that are relatively less wealthy. Hence, the model links those who are relatively rich with those who are relatively poor but have skills through an efficient intermediation of the banks. The model is based on the concept of a savings account with an overdraft facility; hence, until the private sector does not go ahead and test the model, we cannot claim the level of success of the model. However, without testing the model, we also cannot refute the theoretical advantages of the model.

Note 1 On average skilled people in our society do not show up for doing such small problematic tasks as they do not expect reasonable reward for such services.

References Akhtar, S., & Shahnaz, L. (2005). Understanding the youth unemployment conundrum in Pakistan: Preliminary empirical macro-micro analysis. Indian Journal of Labour Economics, 49(2), 233–248. Amjad, R. & Nasim, A. (1992). The employment challenges for Pakistan in the 1990s. MPRA Paper No. 39265. Anwar, M., Faridi, M. Z., Chaudhry, I. S., & Majeed, A. (2010). The determinants of self-eployment in Pakistan: evidence from primary data analysis. MPRA Paper No. 28196. Online at http://mpra.ub.uni-muenchen.de/28196/. Aqil, M., Qureshi, M. A., Ahmed, R. R., & Qadeer, S. (2014). Determinants of unemployment in Pakistan. International Journal of Physical and Social Sciences, 4(4), 676–682. Arslan, M. & Zaman, R. (2014). Unemployment and its determinants: a study of Pakistan economy (1999–2010). Journal of Economics and Sustainable Development, 5(13), 20–24.

117

A nwar S hah

Chien, Y. W. & Devaney, S. A. (2001). The effects of credit attitude and socioeconomic factors on credit card and installment debt. Journal of Consumer Affairs, 35(1), 162–179. Fernando, N. A. (May 2006). Understanding and Dealing with High Interest Rates on Microcredit – A Note to Policy Makers in the Asia and Pacific Region. Manila, Philippines, ADB, p. 8. Ghayur, S. & Burki, A. A. (1992). Combating unemployment in Pakistan [with comments]. The Pakistan Development Review, 31(4), 1255–1266. Haider, A. (2010). Can sectoral re-allocation explain the jobless growth? Empirical evidence from Pakistan. The Pakistan Development Review, 49(4), 705–718. Hayhoe, C. R., Leach, L., & Turner, P. R. (1999). Discriminating the number of credit cards held by college students using credit and money attitudes. Journal of Economic Psychology, 20(6), 643–656. Irfan, M. (2000). Youth employment and unemployment in Pakistan-an overview of 1990’s. PIDE, MPRA Paper No. 38154. Sarwar, N. & Mubarik, M. S. (2014). Foreign direct investment (FDI) and employment: a case of province of Punjab, Pakistan. The Economics and Finance Letters, 1(7), 59–65.

118

9 LESSONS FROM THE UK’S DEDICATED ISLAMIC BANKS Mohammed Amin

9.1 Introduction This chapter considers what wider lessons can be drawn from the historical experience of the UK’s six dedicated Islamic banks. When the author was the Head of UK Islamic Finance at PricewaterhouseCoopers LLP, he had significant contact with the management of all Islamic banks that were then in operation. i.e., all except ADIB (UK). He has continued to have some contact after retirement. However, everything in this chapter is based upon a review of the publicly available financial statements of these banks. It contains no private information. No attempt has been made to reproduce the full details of each company’s financial accounts, as this would be excessively laborious. Nor has the author attempted to present identical information for all six banks, for two reasons: 1 2

While all the accounts are prepared under the same accounting principles, there are some detailed differences in presentation. Different items of information struck the author as particularly notable for different banks. The purpose of summarising the accounts was primarily to gain a better understanding of each bank’s behaviour, and only secondarily to make cross-ban comparisons, particularly as each bank had somewhat different ownership structures and perceived objectives.

9.2 A note on terminology When making presentations to students who are new to Islamic banking, the author stresses that Islamic banking is simply banking that is done in a shariah-compliant way. All commercial issues that apply to conventional banks also apply to Islamic banks. The only difference is that Islamic banks also need to be DOI: 10.4324/9781003050209-9

119

M ohammed A min

Table 9.1 Conventional and Islamic Finance Terminology Conventional terminology Borrower Loan Interest rate Fixed rate loan Depositor

Islamic finance terminology. A customer who is financed by the bank. Customer financing arrangement. The price built into the customer financing arrangement. A customer financing arrangement where the implied cost of finance is not repriced throughout the duration of the arrangement. A customer who has placed money with the bank in a profit-sharing investment account or in a current account.

shariah-compliant in accordance with the requirements of their Shariah Supervisory Board. Accordingly, it is often much clearer to use the language of conventional banking to discuss the business issues in Islamic banking. For example, Islamic banks do not provide interest-earning loans to borrowers. Instead, they finance customers using shariah-compliant arrangements that include the cost of the finance being provided. Simple economic analysis will show that in almost all cases, the financing arrangement is equivalent to either a conventional fixed rate loan or a conventional floating rate loan. In such circumstances it is much more concise, and clearer to the reader, to use the terminology of conventional finance than the terminology of Islamic finance, as illustrated in Table 9.1.

9.3 Why Islamic banks avoid lending on economically profit-sharing terms Students new to Islamic finance expect most lending provided by Islamic banks to be on profit-sharing terms. Much theoretical work has also been done on devising profit-sharing contracts for use in Islamic banking. See, for example, the paper “Two-tier Mudarabah as a mode of Islamic financial Intermediation” by Maas Riyaz Malik written as part of his studies at INCEIF in November 2010, which can be downloaded from SCRIBD.1 While the language of profit-sharing often appears, a closer inspection of the economics of the arrangements used shows that at least in the UK, almost all finance provided by Islamic banks is not profit-participating. Instead, Islamic banks provide most of their finance using fixed return contracts such as murabaha and ijarah. As a simple illustration, consider the 31 December 2015 accounts of The Bank of London and the Middle East plc, freely available from its website. The balance sheet shows customer financings of £613,753,000. From note 21, 120

U K’S ISLA MIC BA N K S

after adjusting for sukuk holdings and impairment provisions, the author computed that 99.1% of the customer financings were murabaha, while only 0.9% were musharaka and mudarabah combined. The key point that many often forget is that Islamic banks are, first and foremost, banks. That means their purpose is to make a profit for their shareholders by receiving money from one set of customers (depositors) and using that money to provide finance to other customers (borrowers). While many advocates of Islamic banking are keen on having banks take genuine equity participation risk when financing projects, that is not normally the objective of the banks concerned. Providing finance with genuine equity participation is a much riskier proposition than providing finance that has the economic characteristics of debt finance. In practice, as explained below, such equity participation risk is not wanted by either banks or their customers. Banks do not want equity participation risk because it exposes them to the risk of serious loss. Furthermore, regulators will require a higher level of bank capital to be allocated against equity-based financings than against debt-based financings. Also, in countries where fiduciary standards are low, it is not uncommon for customers to falsify their accounts when the returns they must pay to the bank are directly linked to the results of their business. Most customers also do not want financing that involves genuine equity participation. Because of the higher levels of risk, anyone providing finance on genuine equity participation terms requires a much higher rate of return than someone providing finance on debt-based terms. That higher rate of return obviously represents an increased cost to the customer who is being financed. Accordingly, notwithstanding the regular entreaties of advocates of Islamic finance, Islamic banks in the real world remain incredibly reluctant to provide finance to customers on terms that involve genuine equity participation. In practice, almost all Islamic finance provided by banks uses contracts such as murabaha that have debt-based (fixed return) characteristics. The above behaviours are not a failing of Islamic banks. They are an essential consequence of them being banks, and it is just how conventional banks also behave. In conventional finance, equity-based finance comes from other providers such as individual high net worth individuals, venture capital funds, and other investment companies. They in turn typically have permanent or semi-permanent capital, owned by people who can afford the losses that may arise, instead of being financed by deposits from people who will want their money back, in full, in a relatively short timescale. To the extent that the Islamic finance community requires equity-based finance, it needs to develop Islamic equity capital providers mirroring those found in conventional finance. Indeed, many already exist. However, providing equity-based finance is simply not the commercial purpose of Islamic banks, regardless of how much some people may want it to be. 121

M ohammed A min

9.4 Historical overview of the UK’s Islamic banking scene 9.4.1 How the industry came about The number of British Muslims has increased significantly in recent decades. The most recent census, in 2011, reported just under 3 million Muslims in the UK. While many Muslims were prepared to use conventional finance, some were not. Accordingly, conventional banks (both UK based and UK branches or subsidiaries of banks from overseas countries) began to offer shariah-compliant home purchase arrangements, as well as other Islamic financial services occasionally. Around 2004, a group of investors decided to create a dedicated UK Islamic bank, which was eventually launched as Islamic Bank of Britain plc, a retail bank. This started business in 2005 and was followed over the next few years by the launch of four other dedicated Islamic banks that were set up as corporate banks. There was then a delay, mainly due to the impact of the global financial crisis, before the sixth UK Islamic bank, ADIB (UK) Ltd, opened in 2012. 9.4.2 How it is regulated From the very beginning, the UK government has applied the fundamental principle that it does not wish to be involved in religious issues. Accordingly, shariah-compliant finance is regulated under precisely the same rules as those applicable to conventional finance. Where shariah-compliant finance may involve some regulatory uncertainty, any necessary revisions to UK financial services regulatory law are expressed in religion-neutral language and those regulatory changes apply equally to Islamic finance and to conventional finance. For example, at one stage many lawyers were concerned that a sukuk arrangement could constitute a collective investment scheme for UK regulatory purposes, which would have created onerous regulatory problems for the sukuk issuer. This problem was resolved by defining a new legal structure, “Alternative finance investment bonds” and specifically exempting them from being a collective investment scheme.2 Nothing in the legislation precludes a conventional bank from issuing an alternative finance investment bond without caring that it is not shariah-compliant; such an instrument would still be exempted from being a collective investment scheme. 9.4.3 How it is taxed With the UK tax system having developed in an exclusively conventional finance environment, there were significant tax problems for Islamic financial 122

U K’S ISLA MIC BA N K S

transactions. For example, a shariah-compliant home purchase arrangement normally doubled the cost of stamp duty (the name for the UK’s real estate transfer tax, since replaced by stamp duty land tax) compared with a conventional mortgage. As a result of a working party convened by the Bank of England, Parliament changed UK tax law starting in 2001 to eliminate the double stamp duty cost of shariah-compliant home purchase arrangements. When the first UK Islamic bank was being planned, to avoid the transactions that such a bank would carry out giving rise to significant uncertainty regarding their corporation tax and income tax treatment, the UK modified its tax law starting in Finance Act 20053 with the aim of ensuring that Islamic finance and conventional finance were on a “level playing field”, so that Islamic finance was not treated either more harshly nor more generously than conventional finance. As with the approach to financial services regulation mentioned above, the UK has carefully avoided the introduction of religion into its tax law. Accordingly, the law defines certain kinds of transactions in non-religious language, avoiding any use of Arabic, and then stipulates a tax treatment. This tax treatment applies irrespective of whether the transaction is shariah- compliant or not.

9.5 A closer look at the UK’s six dedicated Islamic banks The banks are reviewed below starting with the four corporate banks, and then the other two, one of which is for retail customers and the other, which primarily seeks to serve high net worth individuals and companies who are existing customers of Abu Dhabi Islamic Bank PJSC.

9.6 European Islamic Investment Bank plc (EIIB), now called Rasmala UK Ltd Table 9.2, using figures from the published accounts, shows the results of the EIIB from calendar 2005, which was the first year of operation. EIIB started with equity shareholders’ funds of £111 million, which was increased by additional share issues up to the end of 2007 to total equity shareholders’ funds of £181 million. Since then, it has been reduced by a combination of the above losses and some returns of unwanted excess equity back to the shareholders. 9.6.1 Why did EIIB perform so badly? In the author’s view, one key reason is frequent changes of management and of strategy. The accounts report the executive directors as follows (Table 9.3). 123

124

111.2 112.4 185.7 236.3 180.9 316.8 163.4 277.7 140.4 167.0 143.0 181.5 128.7 158.9 119.7 171.7 122.9 153.6 122.2 138.4 101.0 116.7 90.1 106.5 58.7 74.5 58.7 68.7 Cumulative losses

1.3 1.2 −4.5 −14.8 −22.2 −5.9 −11.4 −11.0 −0.1 0.6 0.2 −8.4 −1.6 −1.4 −78.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

YearEnd Total Assets £m

Year-End Equity Shareholders Funds £m

Calendar Profit Year (Loss) after Tax £m

– 30.6 45.7 52.7 21.3 21.6 6.7 – 11.4 7.8 – – – –

Year-End Customer Financings before Impairments £m

Table 9.2 Results of EIIB from Calendar 2005

3.7 10.1 10.4 6.7 – – – – – – –

– – –

–

– 0.9 2.8 2.7 1.0 1.0 0.1 0.1 – – – –

Impairments Liability to Reported Customers in Balance £m Sheet £m

53.7 38.7 – – – 1.7 1.7 1.7 1.1 5.4 5.4 5.4

Principal Investing Assets – Property Portfolio £m

Principal Investing Assets – Private Equity Financial Assets £m

7.0 26.3 14.3 – 16.2 – 13.3 – 15.8 – 16.7 – 19.8 – 8.3 – 6.7 – 6.8 Capital injected, net

Principal Investing Assets – Oil and Gas Properties £m

109.8 73.2 0.1 – −4.2 −2.1 – 0.4 7.2 – −20.0 – −23.4 – 141.0

Share Capital Increase during Year/ Capital Repaid to Shareholders £m

U K’S ISLA MIC BA N K S

Table 9.3 European Islamic Investment Bank Executives 2005–2018 Reported at 31 Chief Executive December

Finance Director

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Tony Ellingham Atif Raza Atif Raza Keith McLeod Keith McLeod Keith McLeod Keith McLeod Keith McLeod None None Neil McDougall Neil McDougall Neil McDougall Neil McDougall

John Weguelin John Weguelin John Weguelin John Weguelin Keith McLeod (acting CEO) Subhi Benkhadra Zulfi Caar Hydari Zulfi Caar Hydari Zulfi Caar Hydari Zulfi Caar Hydari Zulfi Caar Hydari Zulfi Caar Hydari Zulfi Caar Hydari Zulfi Caar Hydari

In the first five years of operation, there was continuity of CEO but three different finance directors. This was followed by a period while the finance director stayed in post but there were several CEOs. The years 2013 and 2014 without a finance director in place are particularly disturbing. The concern is that the absence of a finance director indicates that the authority of the finance function within a firm has been downgraded. A key role of the finance director is to ensure that the firm is managing its downside risks. On reading the accounts, one also finds many changes in strategy; some of the biggest losses appear to have arisen from forays into principal investing. In recent years, the strategy has changed to managing assets for clients. This should lower risk and require less capital. There were large reductions in equity shareholders’ funds in 2015 and 2017, which were due to planned returns of capital to shareholders. However, the results up to the end of 2018, the most recent available, show that this company had not yet stabilised to the extent of being able to make reliable profits. Indeed, it was still making losses.

9.7 Bank of London and the Middle East plc The Bank of London and the Middle East Plc (BLME) is the largest dedicated Islamic bank in the UK. Its annual results are summarised in Table 9.4. BLME did make profits in 8 out of the 12 years, but the best result, a profit of £10.7 million in 2018, was only 4.7% of shareholders’ funds. Banks typically aspire to have a return on equity exceeding 10%. In the other four years, the bank made large losses. Since starting, BLME has incurred a cumulative loss of £20.9 million of shareholders’ money. 125

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

0.2 2.4 −13.2 3.5 −8.9 3.8 4.3 1.0 −6.8 −21.4 3.5 10.7 −20.9

Year-End Total Assets £m

179.4 297.7 252.4 867.3 243.5 758.7 247.0 711.9 238.6 807.1 239.6 1,039.0 242.8 1,233.7 243.8 1,385.5 237.8 1,300.3 217.1 1,032.4 220.5 1,025.9 228.1 1,272.9 Cumulative losses

Calendar Profit/ Year-End Year (Loss) Shareholders after Funds £m Tax £m

11.9 136.0 178.2 207.5 224.3 236.8 276.2 212.7 322.2 257.1 204.7 299.7

Finance Lease Receivables + Operating Lease Assets £m 52.1 329.4 319.9 330.2 320.1 381.5 616.9 740.6 646.8 488.6 577.8 711.2

Year-End Customer Financings before Impairments £m 0.9 15.9 6.2 21.0 22.1 22.3 33.3 33.1 15.3 11.2 10.3

–

Impairments Reported in Balance Sheet £m

Table 9.4 The Annual Results of the Bank of London and the Middle East plc 2007–2018 Principal Investing Assets – Property Portfolio £m

5.6 – 4.7 8.4 8.0 6.9 24.3 7.2 51.0 12.8 257.7 27.8 308.4 24.3 471.4 28.6 321.5 26.8 213.8 – 277.3 – 357.4 – Capital injected, net

Liability to Customers £m

179.5 75.5 – – – – – – – – – – 255.0

Share Capital Increase during Year, Net of Any Own Share Purchases £m

M ohammed A min

126

U K’S ISLA MIC BA N K S

The results look bad, until one compares them with those of other Islamic banks. There are many reasons why BLME has found it so difficult. Firstly, the decade since the global financial crisis has been hard for most banks. Regulators have imposed many additional risk-management costs upon banks such as increased anti-money-laundering compliance, amongst others. These additional costs come on top of the unavoidable operating costs of any bank such as having an internal audit department, financial accounting systems, a board of directors, etc. All costs of this kind bear much more heavily on a small bank such as BLME than they do on much larger conventional banks. For example, at the end of 2017, Barclays plc had shareholders’ funds of £66 billion, making it 300 times larger than BLME. Barclays has a much larger base over which it can spread its overhead costs. As well as the inefficiencies from being small, being a new player in the market is always hard. Banks make money by using their own capital plus money from customers (deposits) to finance other customers. Most of the finance is provided using customers’ money. For example, Barclays plc had assets (mainly customer financings plus cash and investments held for prudential purposes) of £1,133 billion, which is 17 times its capital of £66 billion. In comparison, at the end of 2017 BLME’s total assets of £1,026 million were only 4.6 times its shareholders’ funds of £220.5 million. The lower that ratio, the harder it is for a bank to make money. BLME has simply not managed to scale up its deposit taking and financing activities sufficiently to earn a reasonable rate of return on its equity. Finally, there is another problem from being a new bank. It is harder to find reputable customers to finance at an acceptable rate of profit return. BLME has clearly suffered from this problem. The accounts show that in the years when there were big losses, they arose from impairments. That is accounting terminology for the losses a bank suffers from providing finance to businesses that are no longer likely to pay it back.

9.8 Gatehouse Bank plc Gatehouse Bank plc (Gatehouse) was also established in the mid-2000s. The optimism about the banking industry at that time, before the global financial crisis, and the era of low interest rates, is hard to remember from the perspective of 2020. Gatehouse was established as a wholly owned subsidiary. Its 2007 accounts report its parent company as The Securities House KSCC. A KSCC is a type of Kuwaiti company that is prohibited from conducting banking or insurance business, so Gatehouse was not the subsidiary of a bank. In later 127

M ohammed A min

years, The Securities House KSCC reduced its shareholding as Gatehouse issued extra share capital. Table 9.5 shows the key figures up to the year ended 31 December 2018, the latest accounts on its website. These accounts tell a sorry tale. The first-year loss is no surprise. Operational costs are inevitably incurred before a new bank earns anything. However, the second year shows increased losses from staff and other operational costs significantly exceeding income. Gatehouse by then had £50 million of share capital, but almost no liabilities to customers. Almost all assets were interbank placements. A bank cannot be profitable that way. Management of new banks that are short of earning assets are often tempted to make customer advances that other banks might not, convincing themselves that the credit quality will be acceptable. That appears to have happened with Gatehouse, since the significant increase in losses for 2009 is primarily attributable to impairment provisions. In the following two years the losses reduce, followed by three years of small profits. However, by then another £100 million of extra share capital had been injected. Even in its best years, 2013 and 2014, the return on average shareholders’ equity was only 3.4%. For that to be the best result is lamentable. In 2018 the bank reported another large loss, primarily due to recognising £12 million negative revaluation on finance provided to a customer in 2013 for real estate construction in France. Stepping back, over its life, the shareholders have injected £150 million of capital and watched more than 25% of it being lost. Despite that, each year, including 2018, the accounts have upbeat language, with little detail about problems or strategic challenges. Gatehouse Bank is not alone. The same was true with the other Islamic banks’ accounts.

9.9 QIB (UK) plc QIB (UK) plc is a UK Islamic bank that is a wholly owned subsidiary of Qatar Islamic Bank. It was once commonplace for foreign banks to set up UK branches. However, UK regulators have become very reluctant to permit new UK branches. Instead, they require the foreign bank to incorporate a UK subsidiary, independently regulated by the UK, with independent non-executive directors alongside the management that may have come from the overseas parent. There is always an inevitable tension between the regulatory and taxation requirements that the UK subsidiary operates independently, with all transactions with its foreign parent on arm’s-length terms, and the business reality that the UK subsidiary is the creation of its parent. QIB UK became operational in 2007, although that year was spent getting started. In Table 9.6 is a summary of its historical results. 128

5.6 7.4 37.2 53.9 25.2 48.4 19.5 31.4 115.2 163.5 117.4 205.2 119.1 224.1 125.5 263.5 122.2 281.8 128.9 300.0 127.5 280.5 110.5 435.6 Cumulative losses

129

7.8 13.1 14.8 21.3 39.6 41.9 70.4 106.0 135.7 85.9 302.5

–

Liability to Customers £m

– – – 1.4 3.2 1.2 – – 5.3 6.1 6.0 17.3 6.2 2.7 6.6 2.6 – 11.5 – 58.3 – 73.3 – 318.8 Capital injected, net

Impairments Reported in Balance Sheet £m

10.0 40.0 – – 100.0 −1.0 – 1.0 – – – – 150.0

Share Capital Increase during Year, Net of Any Own Share Purchases £m

Note: The 2018 liability of £318.8 million includes both liabilities to customers and to financial institutions. Liabilities to customers are no longer identified separately in the accounts.

−4.4 −8.5 −12.1 −5.7 −4.3 2.4 4.0 4.1 −0.8 1.6 −0.4 −15.9 −40.0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Year-End Year-End Total Assets Customer £m Financings before Impairments £m

Year-End Shareholders Funds £m

Year Ended Profit 31 December (Loss) after Tax £m

Table 9.5 Financial Summary of Gatehouse Bank plc (2007–2018)

U K’S ISLA MIC BA N K S

Profit (Loss) after Tax £m

−2.8 −2.4 −1.7 −1.2 0.1 −3.4 −15.7 1.3 2.5 −3.1 1.7 3.7 −21.0

Calendar Year

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 14.0 22.5 24.6 36.7 52.4 36.7 89.0 227.8 293.0 403.3 489.0

–

Year-End Year-End Total Assets Customer £m Financings before Impairments £m

– 3.1 19.8 48.2 18.1 49.9 16.9 60.1 17.0 131.0 13.9 168.5 16.4 151.2 30.5 226.4 55.6 428.2 51.9 516.9 60.1 529.8 62.8 621.8 Cumulative losses

Year-End Shareholders Funds £m

Table 9.6 Financial Summary of QIB (UK) plc (2007–2018)

– – – 15.2 −0.9 7.7 −1.5 11.4 −1.6 81.1 −5.3 102.8 −2.4 67.9 −0.7 153.1 −0.6 216.0 −2.7 388.4 −5.0 366.6 −6.6 434.5 Capital injected, net

Impairments Liability to Reported in Customers Balance Sheet £m £m

130

85.8

6.2

19.0 12.5 23.1

– 25.0

Share Capital Increase during Year, Net of Any Own Share Purchases £’m

M ohammed A min

U K’S ISLA MIC BA N K S

The overall story is lamentable. Since operations started, the parent company has injected £85.8 million into QIB UK. Of this, £21 million has been lost. The loss in 2007 was predictable since costs were unavoidably incurred when negligible banking business was being undertaken. However, the losses continued year by year, culminating in a stupendous loss in 2013. The 2013 accounts explain that QIB UK had built up a significant portfolio of financings to development stage SME businesses that were proving non-viable. It had also taken equity stakes in those businesses. Impairment losses on those financings plus write-downs of the equity stakes represented the bulk of the loss. This accumulation of high-risk activity illustrates the business challenges faced by small new investment banks. They lack the deal flow of larger and more established competitors, which tempts them to take on risky customers. The temptation to seek higher, and therefore riskier, returns is increased by their small size, which makes it harder to spread their fixed overheads. In recent years, QIB UK appears to have stabilised. While the 2018 return on equity of 6% is not brilliant, given the generally difficult banking environment, it can be regarded as respectable. The 2018 accounts show that most of QIB UK’s customer financings are relatively short-term financings of real estate transactions with little over five years’ maturity. However, that poses its own risk of the bank becoming overexposed to real estate.

9.10 Islamic Bank of Britain plc, now called Al Rayan Bank plc Islamic Bank of Britain plc (now called Al Rayan Bank plc) was set up in mid-2004. It was the UK’s first Islamic bank, and until recently its only retail Islamic bank. Until 2014, the results were steady losses, with the bank facing eventual insolvency. Then they changed. From inception, the bank steadily lost money, relying upon additional injections of shareholders’ funds to avoid having to shut down. The problem was that the bank was too small. Its 2005 capital was only £40.5 million. Its strategy involved physical branches, which entailed relatively high fixed costs. Those could only be justified if the branches facilitated a large volume of income earning customer financings. Unfortunately, the bank’s small capital severely constrained the amount of customer financing it was permitted to do. The table shows that deposits from customers (customer liabilities) vastly exceeded customer-financing assets. The excess deposits were invested in the Islamic interbank money market but will have earned relatively low rates of return. 131

M ohammed A min

Accordingly, the bank was effectively locked into losing money steadily year after year. If it had not been taken over, it would eventually have had to shut down once its shareholders were tired of putting in additional share capital to cover its operating losses. After the takeover, it is a different story. The year 2014 shows an exceptionally large increase in shareholders’ funds. This additional share capital allowed a dramatic increase in customer financing assets while the branch network was essentially unchanged. Accordingly, the bank’s customer financings were able to grow, but without any corresponding increase in the bank’s operating costs. Hence, it began making a profit (Table 9.7). Subsequently, the additional capital has allowed continued growth in customer-financing assets. Accordingly, the annual profit has grown to a more respectable figure. Although the return on equity remains well under 10%, that is not too bad in the challenging environment of UK retail banking. For example, the conventional industry’s UK-focused retail banking giant, Lloyds Banking Group PLC, achieved a 2017 return on equity of only 6.5%. There remains significant scope for growth in customer financing assets, as shown by its sukuk issue discussed below. Table 9.7 Financial Results of Al-Rayan Bank plc (previously Islamic Bank of Britain plc) 2007–2018 Calendar Profit/ Shareholders’ Customer Year (Loss) after Funds £m Financing Tax £m Assets £m

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

−5.8 −6.4 −8.8 −6.9 −5.9 −9.5 −8.1 −9.0 −7.0 −5.7 1.2 10.3 9.5 8.6 6.4 −31.3

47.0 40.5 31.7 24.8 18.9 16.8 26.2 17.1 20.1 24.3 103.1 113.5 123.3 128.8 135.0 Cumulative losses

–

Customer Share Capital Liabilities Increase during £m Year, Net of Any Own Share Purchases £m

2.1 4.4 47.7 10.3 83.8 15.6 134.6 23.4 153.3 46.1 186.0 54.2 187.8 69.3 195.2 129.0 237.5 241.5 320.4 450.2 509.8 725.4 730.7 1,031.2 1,222.8 1,406.1 1,596.7 1,633.2 1,547.5 Capital injected, net

132

52.9 – – – – 7.3 17.5 – 10.0 10.0 75.7 – – – – 120.5

U K’S ISLA MIC BA N K S

9.10.1 Al Rayan Bank plc sukuk issue In 2018, Al Rayan Bank plc made the first ever UK Islamic bank sukuk issue specifically to enable it to continue expanding its home purchase plan assets. The prospectus issued by Tolkien Funding Sukuk No. 1 Plc (the sukuk issuing special purpose vehicle) is freely available on the internet.4 It makes interesting reading. Reading the 211 pages reinforces the point made earlier in this chapter. Islamic banking is banking, and the business models of Islamic banks are essentially the same as those of conventional banks. The only difference is that Islamic banks conduct their business in accordance with guidelines set by shariah scholars. In the case of this sukuk, the point is demonstrated by asking two questions: 1 2

How does Al Rayan Bank benefit from issuing the sukuk? What do the investors get from buying the sukuk?

9.10.2 How Al Rayan Bank benefits from issuing the sukuk As explained above, Islamic Bank of Britain (IBB) made losses for many years. After IBB was taken over by the Qatari bank Masraf Al Rayan in 2014 and renamed, it received a big capital injection. This allowed it to provide commercial property finance, and residential finance in the form of home purchase plans, which are diminishing musharaka transactions. Since then, the bank has been profitable. The accounts for the year ended 31 December 2016 show that during 2016 commercial and residential property financing combined increased from £728 million to £1,031 million. In 2017, they increased again to £1,406 million. It is of course one of the functions of banks to transform maturities, by “borrowing short” (taking deposits that are repayable on demand or in a short time period) while “lending long.” They can accept this liability mismatch because they are confident that as some short-term deposits are repaid, other customers will make new short-term deposits. However, as the mismatch between long-term assets (home purchase plans and property financing) and short-term financing (deposits) grows, the risk for the bank also increases. Accordingly, banks mitigate their maturity risk by obtaining some funding, which is longer term. Such longerterm funding is normally more expensive than short-term funding, as the yield curve (showing the market interest rate for different maturity periods) normally slopes upwards. 133

M ohammed A min

The sukuk issue enabled Al Rayan Bank to obtain a three-year funding on relatively attractive terms. Al Rayan Bank sold home purchase plans on which customers owed £301 million to Tolkien for £245 million + a promise to pay the £56 million balance in the future. From a sukuk investor’s perspective, buying the sukuk was less risky than lending money to Al Rayan in the form of a three-year deposit for two reasons: 1

2

The sukuk issuing entity owned the home purchase plans and the cash flows from these plans would go directly to the sukuk investors. Conversely, a depositor of the bank only has a debt-claim against the bank that ranks equally with all its other debts, and does not have a prior claim against any particular assets. Accordingly, the sukuk is equivalent to Al Rayan Bank issuing debt, which is secured by a first charge against specific assets, namely home purchase plans. The sukuk was for only £245 million, but £301 million of home purchase plans had been transferred to the sukuk issuing entity. Accordingly, the sukuk was “over-collateralised”, reducing the risk that the cash flows from the home purchase plans would be insufficient to repay the sukuk.

These two factors meant that investors were willing to buy the sukuk at a yield (three-month sterling LIBOR + 0.8%) that was almost certainly significantly lower than they would have demanded for buying unsecured threeyear debt issued by Al Rayan Bank. By issuing the sukuk, Al Rayan Bank reduced its asset / liability maturity mismatch, while obtaining funding at an attractive price. 9.10.3 What the investors get from buying the sukuk What the investors receive from the sukuk are income payments computed as three-month Sterling LIBOR + 0.8%. These are paid from the rental payments that Tolkien receives from the householders under the home purchase plans. If there is an income shortfall, neither Tolkien nor Al Rayan Bank are liable, but this is very unlikely given the levels of rent payable by the householders and the £56 million deferred consideration. After three years, the income payments increase to three-month Sterling LIBOR + 1.6%. Unless Al Rayan Bank is then experiencing difficulties, it can be expected to exercise its contractual right to buy back all the home purchase plans for a price equal to the outstanding balance on the sukuk. Effectively, the sukuk investors will receive what any securitisation investor receives, namely a return specified in advance (here LIBOR + 0.8%) provided that the underlying assets perform more or less in accordance with expectations. 134

U K’S ISLA MIC BA N K S

What they will not receive, nor expect, is any upside from the underlying assets. That is because the sukuk instruments are not intended to provide true equity participation in the assets used to enable the creation of the sukuk. 9.10.4 ADIB (UK) Ltd The banks mentioned above were all established in the optimistic years leading up to the global financial crisis. The sixth UK Islamic bank is slightly different. ADIB (UK) Ltd opened in 2012, a few years later than the others. However, that has made no difference to its performance compared with its predecessors. ADIB (UK) is a wholly owned subsidiary of Abu Dhabi Islamic Bank PJSC, which, by Islamic banking standards, is a reasonably sized bank, with 31 December 2018 total equity equivalent to US $4.8 billion. The accounts state that ADIB (UK)’s goals are to serve ADIB Group priority, high net worth and corporate customers. One cannot tell from reading the accounts whether it has developed any significant independent customer base. Reading the accounts, unlike some of the other UK Islamic banks, there is no sign of any material impairment losses from taking on customers who prove to be poor credit risk. Despite that, as shown by the results in Table 9.8, the bank has consistently lost money. The consistency of the results, with small losses every year, is striking. Each year net financing income has failed to cover its operating costs. The figures show that the business activities have been sub-scale. In relation to its equity, it has attracted relatively small levels of customer deposits. On the asset side of its balance sheet, customer financings have always been relatively low as a proportion of total assets, with the balance of the assets comprising sukuk holdings and inter-bank placements. Given the low interest rate environment following the global financial crisis, the margin between what ADIB (UK) earns on its assets and what it pays on its customer deposits has been insufficient to cover its operating costs. The losses have not been dramatic, due to the successful avoidance of material impairment losses, but they have been steady. The key statistic to look at is shareholders’ funds as a percentage of total assets, without risk-weighting the assets. Shareholders’ funds have been as high as 60%, and even by 2018, when they had fallen, were 14%. With these being non-risk-weighted numbers, the figures are far too high. Banks cannot make money this way unless they have incredibly significant income from fee-earning services. The other factor that stands out when reading the results is management stability, or rather the lack of it. When a bank has regular changes of management, as seen above with EIIB, one expects to find significant losses. Table 9.9 lists the management. 135

Profit (Loss) after Tax £m

−2.5 −2.3 −3.7 −4.0 −4.0 −3.3 −2.1 −21.90

Calendar Year

2012 2013 2014 2015 2016 2017 2018

Year-End Total Assets £m

7.5 68.0 27.6 81.6 23.6 94.0 45.3 75.6 41.5 156.9 37.9 149.3 32.3 223.4 Cumulative losses

Year-End Shareholders Funds £m

Table 9.8 Financial Summary of ADIB (UK) 2012–2018

136 7.0 15.9

71.0 77.9 153.7

–

–

Liability to Customers £m

– 13.0 – 21.0 – 26.5 – 28.0 – 37.2 – 30.8 – 41.6 Capital injected, net

Year-End Impairments Customer £m Financings before Impairments £m

10.0 21.9 – 26.1 – – – 58.00

Share Capital Increase during Year, Net of Any Own Share Purchases £m

M ohammed A min

U K’S ISLA MIC BA N K S

Table 9.9 Changes in Management of ADIB (UK) 2012–2018 Reported at 31 December

CEO

COO/CFO

2012 2013 2014

Edwin Manning None stated Stuart Taylor appointed and resigned early next year Masarrat Husain Masarrat Husain Bruno Martorano Bruno Martorano but resigned early 2019

Kishan Medimi Kishan Medimi None stated

2015 2016 2017 2018

Keith McLeod Keith McLeod Keith McLeod Keith McLeod

In the seven years reviewed, there were four chief executives, and a year when no chief executive was named. This suggests that the parent company was dissatisfied by ADIB (UK)’s performance. However, changing personnel is not a solution unless one also changes the strategy.

9.11 Summary of financial results For a quick comparison of the banks, it is helpful to look at their aggregate results from commencement to 31 December 2018, which is the date of the most recent available accounts. As shown by the previous individual results tables, all the banks have made aggregate losses since they started. It helps to compare those losses with the amount of capital the shareholders have injected into the banks concerned, net of capital withdrawals. Table 9.10 shows that the largest of the banks, BLME, performed comparatively best. Its losses represent only 8% of the capital injected into the bank. EIIB was at the opposite extreme, having lost 55% of the net injected capital. In the author’s view, the main reason for the comparatively better performance of BLME was consistency of management. Unlike some of the other banks, this chapter does not tabulate BLME’s management, but for most of its history, it had the same person as CEO and the same person as CFO.

9.12 Why the corporate banks were established in the UK In the author’s opinion, there were three separate reasons. 9.12.1 The general attractiveness of the UK as a base for international financial business There are several factors that make the UK in general, and London in particular, extremely attractive. 137

M ohammed A min

Table 9.10 Summary of Financial Results Bank

Cumulative Losses since Commencement

Cumulative Capital Cumulative Losses Injections from as % of Capital Shareholders, Net of Invested Repayments

EIIB, now Rasmala BLME Gatehouse QIB (UK) IBB, now Al Rayan ADIB (UK)

−78.0

141.0

55%

−20.9 −40.0 −21.0 −31.3

255.0 150.0 85.8 120.5

8% 27% 24% 26%

−21.9

58.0

38%

9.12.2 Political stability The UK has a significant advantage against many jurisdictions that seek to compete with it arising from its political stability. For over 300 years, the UK has had a stable system of government conducted in a transparent democratic framework. This matters for international investors who may wish to channel exceptionally large amounts of money through legal structures that may be in place for generations as in the case of family trusts. While there are other countries such as the United States or Switzerland that offer similar levels of political stability, many other Western countries do not, and there is no Muslim majority country that can satisfy this criterion. 9.12.3 The English legal system English law has become the law of choice for international financial transactions, with the only close competitor being the law of the state of New York. The key competitive advantage here is the highly developed state of the law and its ability to cope with complex financial transactions. The English courts are a particularly attractive forum for the settlement of disputes. They have a key advantage over US courts in that a successful litigant can be awarded costs. Even where the awarded costs do not cover the full costs incurred by the successful litigant, the position is far better than under the US legal system where each party bears its own costs. In the context of Islamic finance, the approach of the English courts to shariah law provides significant benefits to investment banks and their customers by ensuring contractual certainty. The leading case in this area is the Court of Appeal decision in Beximco Pharmaceuticals Ltd vs Shamil Bank of Bahrain 2004 EWCA Civ19. 138

U K’S ISLA MIC BA N K S

The governing law clause of the contract concerned read “subject to the principles of the Glorious Sharia’a, this Agreement shall be governed by and construed in accordance with the laws of England.” The bank’s customer was seeking to avoid its liabilities to the bank by contending that the transaction was not fully compliant with shariah. The key point about the approach taken by the Court of Appeal (which at the risk of extreme over-simplification can be described as disregarding any reference to shariah) was that it achieved contractual certainty. Parties who contract under English law are therefore in a much clearer position than parties governed by the law of a Muslim majority country where there is much greater exposure to the contract being set side or varied by the courts on shariah grounds. 9.12.4 Travel and the time zone As an international investment banking location, London has some significant geographical advantages. It is close to continental Europe, and midway between the other major financial centres of Tokyo and New York. Accordingly, staff based here can transact with both of those locations during the working day. For transactions with Muslim majority countries spread across North Africa, the Middle East, the central Asian republics, South Asia and South East Asia, London is much closer than New York and shares more of the working day. In addition to these physical factors are the long-standing UK connections with many Muslim majority countries, dating back to the days of the British Empire and now maintained by the Commonwealth. 9.12.5 Professional resources and the network effect The greatest single attraction of London as an investment banking location is the availability of exceptionally large numbers of skilled personnel, not just investment bankers but also accountants, lawyers, actuaries, consulting engineers, etc. This has led many foreign headquartered banks to locate their investment banking division in London; in turn this attracts to London aspirant investment bankers from all parts of the world. Once many investment banks are in London, it makes sense for new ones to establish in the same place for ease of trading, communications, and deal negotiation as well as staff recruitment. This network effect is the key reason why London is the most attractive location for Islamic investment banks that aim to do business globally, as opposed to serving a single geographical market. London also benefits from the high standing of the UK’s academic institutions. These have traditionally helped to develop conventional bankers, but now the UK boasts several institutions offering Islamic financial training at the highest levels. 139

M ohammed A min

9.13 The UK government’s supportiveness for the development of Islamic finance The earlier text outlined some of the tax and regulatory changes that the UK government has made to ensure that Islamic finance does not face impediments that are additional to those faced by conventional finance. The UK has been far ahead of other European countries in making such changes. 9.13.1 The potential for domestic Islamic business From inception, the corporate banks have set out to do business internationally. This has not always been a success. For example, BLME’s accounts show that its particularly large impairment losses arose from lending to a Saudi Arabian business. However, despite the international objectives, there was also clearly an intention to serve UK Muslim customers. In that regard, the author believes that the Muslim community in the UK is, on average, further advanced in the business sector than Muslim communities in continental European countries such as France and Germany. (Quantifiable data to evidence this is not readily to hand.) The domestic market was however, obviously, less significant for the corporate banks than for retail banks, as discussed below. 9.13.2 The size of the UK retail Islamic banking market and limiting factors IBB was of course established with primarily domestic objectives, to serve the retail banking needs of Muslims in Britain. (It might later expand into continental Europe taking advantage of the ability of EU financial institutions to offer financial services cross-border within the EU.) The size of the retail Islamic banking market in the UK was therefore a critical factor. The number of Muslims in Britain is much better known than the number of Muslims in certain other countries such as France or the USA, where one must rely on estimation. For both France and the USA, the national census does not ask respondents about religious belief. However, both in 2001 and more recently in 2011, the UK national census has directly asked respondents whether they have a religious belief and if so what is it. Considering the 2011 census and more recent large-scale polling, there are approximately 3 million Muslims in the UK, representing about 5% of the population. While that number is much smaller than the 95% of the population, which is non-Muslim, that 95% is contested by many conventional banks. Accordingly, at first sight, the Muslim 5% would appear to be a reasonable target market for the relatively small number of banks wishing to focus on it. Indeed, IBB was the only shariah-compliant retail Islamic bank in the UK, 140

U K’S ISLA MIC BA N K S

although several of the conventional banks have had shariah-compliant “window” offerings. However, it is an oversimplification to regard the addressable market as 3 million Muslims. As illustrated in Figure 9.1, several segments of the Muslim population do not qualify as realistic commercially profitable customers of retail Islamic banks. Many Muslims are outside the addressable market 3m Muslims ? Real retail market

Too young

Not Islamic enough Too poor

Use convenonal

Figure 9.1 Many Muslims are Outside the Addressable Market. Table 9.11 The 2011 Census for England and Wales Depicting the % Age of Young Muslims Age Range

Muslim Numbers

% of Muslims in This Age Range

Cumulative % of Muslim Up to This Age Range

Age 0–4 Age 5–7 Age 8–9 Age 10–14 Age 15 Age 16–17 Age 18–19 Age 20–24 Age 25–29 Age 30–34 Age 35–39 Age 40–44 Age 45–49 Age 50–54 Age 55–59 Age 60–64 Age 65–69 Age 70–74 Age 75–79 Age 80–84 Age 85 and over

3,17,952 1,77,119 1,08,112 2,45,480 46,474 88,982 87,222 2,38,041 2,73,505 2,70,278 2,27,166 1,79,128 1,19,992 97,899 75,000 46,890 33,457 33,742 22,758 11,356 5,513 27,06,066

11.7 6.5 4.0 9.1 1.7 3.3 3.2 8.8 10.1 10.0 8.4 6.6 4.4 3.6 2.8 1.7 1.2 1.2 0.8 0.4 0.2 100.0%

11.7 18.3 22.3 31.4 33.1 36.4 39.6 48.4 58.5 68.5 76.9 83.5 87.9 91.5 94.3 96.1 97.3 98.5 99.4 99.8 100.0

141

M ohammed A min

9.13.3 Muslims who are too young The 2011 census for England and Wales shows that Muslims are an incredibly young demographic. Table 9.11 shows the number of Muslims in each age range. It shows that in 2011, 39.6% of all British Muslims were aged 19 or under. While banks often seek young customers in the hope that they will remain loyal to the bank in later life, young people are generally not profitable retail banking customers. 9.13.4 Muslims who are too poor Many surveys have shown that, on average, British Muslims are poorer than the average Briton. Again, those who are relatively poor are not likely to be profitable retail banking customers.

9.14 Muslims willing to use conventional banking who avoid Islamic finance for cost reasons Many Muslims have no fundamental religious objection to conventional finance, even when some of them object to certain aspects of conventional finance such as exploitative lenders who take advantage of poorer and less well-advised customers. This is demonstrated by the continuing widespread use of conventional finance in some Muslim majority countries that have long-established Islamic financial services providers. In the UK, customers who do not have a religious objection to using conventional banking will generally avoid Islamic banks for straightforward cost reasons. 9.14.1 Why Islamic banking is more expensive in the UK In the UK, retail Islamic banking will always be more expensive than conventional retail banking. There are two reasons for this: 9.14.1.1 The smaller size of Islamic banks Islamic banks are much smaller than the giant conventional banks that dominate the British retail banking market. There are many unavoidable costs of running a bank that are not directly proportional to size but are instead somewhat fixed. Accordingly, such costs bear much more heavily on a small bank than on a large bank that can spread such costs over a much larger customer base.

142

U K’S ISLA MIC BA N K S

9.14.1.2 The additional complexity of Islamic banking A shariah-compliant home purchase plan involves more legal transactions, and therefore more legal documentation, than a conventional house mortgage. That inevitably entails extra costs for the creation of the home purchase plan, which must be recovered from the customer. Both above factors combine to result in a situation where a home purchase plan from a UK Islamic bank will always be more expensive than a conventional mortgage from a large UK conventional bank. 9.14.2 Muslims who do not regard Islamic banks as “Islamic enough” In discussions of Islamic finance, there is relatively little discussion of individuals in this category. However, there are many Muslims who have a religious objection to conventional banking but who also have a religious objection to Islamic banking as practised by real-world Islamic banks. While the religious views of such Muslims are not uniform, in general, the author understands that they regard the mechanisms by which real Islamic banks charge for the provision of finance as being a disguised form of interest, and therefore religiously prohibited. Because of these views, such individuals are not part of the addressable market for a retail Islamic bank. Again, the author has no data regarding the relative proportion of such individuals but has come across many people with those beliefs. The author has never seen any data on the attitudes of British Muslims. It is quite possible that the conventional banks have paid for private polling, but this would be regarded as commercially valuable information that they would be unlikely to publish. Accordingly, the author cannot quantify the relative sizes of the attitude segments discussed above. 9.14.3 Why have all the banks lost money? As shown above by the summary table, all the Islamic banks in the UK have lost money overall since inception. However, some, for example IBB, now appear to have turned the corner and established a stable business, which shows signs of being consistently profitable. There are several factors that together have contributed to the dismal results of the Islamic banks. 9.14.4 The general UK banking environment The banking industry in the UK has struggled ever since the global financial crisis. Quite apart from the direct losses incurred during the crisis when

143

M ohammed A min

securities such as collateralised debt obligations fell dramatically in value and the credit losses incurred during the great recession following the 2008 banking crisis, subsequent years have seen an environment of very low interest rates. Both short-term interest rates and long-term interest rates have been depressed by central bank actions such as quantitative easing. A low interest rate environment makes it much harder for a bank to make money. Firstly, it reduces the absolute return (the interest charged) on the money that the bank has available to lend on which it is not itself paying interest to anyone, namely the money representing its shareholder’s funds and the money it has available by virtue of offering current accounts on which it does not pay interest but instead incurs the fixed operating costs of providing current account services. Secondly, a low interest rate environment in practice has the effect of narrowing the spread that a bank can earn, being the difference between the interest rate that it charges its customers and the interest that it pays on its interest-bearing deposits. That is the main reason why conventional UK banks have been relatively unprofitable even after the economy emerged from the great recession. These factors bear just as strongly on Islamic banks as they do on conventional banks. 9.14.5 The diseconomies of being small As mentioned above, there are some irreducible costs from running a bank, no matter how small the bank may be. Every bank must have a board of directors, a compliance department, basic IT systems etc. The smaller the bank, the greater the burden such costs represent. As seen from their individual financial summaries, all the Islamic banks concerned are very small compared with the giant UK conventional banks. Even the largest, BLME, would be insignificant compared with the balance sheet of one of the large UK clearing banks. This point applies even more strongly to the smaller UK Islamic banks. 9.14.6 The impact of management instability Almost all the Islamic banks have seen many changes in management. Indeed, only BLME has stood out for having extended management continuity. It is hard for a bank to establish an effective working culture when there are regular changes of CEO. It is also disturbing when the CFO changes regularly, and even more disturbing when there are periods without a CFO, as that suggests a lack of focus on risk, which is one of the CFO’s main responsibilities.

144

U K’S ISLA MIC BA N K S

9.14.7 The risk of adverse selection Each of the banks started life as a new bank, with some share capital, money available to lend, and no customers. (ADIB (UK) could be a slightly special case as it inherited the UK activities of customers of its parent bank, and the same logic would apply to QIB (UK).) New banks need borrowers, since the rate of return earned on their funds when invested in the interbank market is relatively low, particularly given the low interest rate environment mentioned above. At the same time, as explained earlier, borrowing from an Islamic bank will typically be more expensive (if the loan is not to be unprofitable for the bank) than a loan from a conventional bank. Accordingly, the bank is at risk of suffering from adverse selection by customers. In other words, a new Islamic bank is likely to attract less creditworthy customers who are willing to pay a higher rate of interest than conventional banks will charge, because they cannot get the credit they need from conventional banks due to being insufficiently creditworthy. Obviously, the Islamic bank will aspire to screen out customers who are not creditworthy, but it is at risk of failing to be sufficiently rigorous because there is also internal pressure within the bank to lend out its funds. 9.14.8 Strategic inconsistency IBB as a retail bank has always had a relatively clear strategy. Its fundamental problem was that it was too small, which meant that it was able to attract deposits but unable to take the business risk of lending those deposits as home purchase plans. Once it had a major increase of share capital after takeover by Masraf Al Rayan, it was able to start lending those deposits effectively. However, it is much harder to discern a consistently executed strategy amongst the corporate banks. EIIB has had regular changes of strategy but without any successful execution. Its current strategy in its new incarnation of Rasmala UK Ltd is to be an asset manager rather than a bank. Gatehouse now appears to be entirely real estate focused, as is QIB (UK). See below regarding asset concentration risk. Perhaps due to management continuity, BLME has had a relatively consistent strategy, offering wealth management from relatively early on, including the promotion of a sukuk fund, and having a leasing portfolio. 9.14.9 Shariah compliance does not differentiate Islamic banks from each other A key concept in business strategy is the distinction between “foundation attributes” and “leverage attributes.”

145

M ohammed A min

A foundation attribute is something that you must have to “play in the game.” For example, you cannot participate in the audit marketplace unless you are a qualified auditor. Foundation attributes however convey no competitive advantage. If every competitor in the audit marketplace is, by definition, a qualified auditor, then yours being qualified does not distinguish you. Conversely, leverage attributes are those that can give you a competitive advantage. For example, you may have developed proprietary auditing software that enables you to perform audits more quickly. In the context of Islamic banking, to call itself an Islamic bank, a bank must satisfy the local requirements for Islamic banks set out by regulators (for example in Malaysia) or by local market practice (for example in the United Kingdom). The shorthand term for satisfying these requirements is to say that the bank is “shariah-compliant.” In the author’s opinion, whether a bank is shariah-compliant is a binary question. The answer is either yes or no. There are no degrees of shariah compliance. To compete in the Islamic banking marketplace, shariah compliance is then a foundation attribute. If a bank fails to be shariah-compliant, its regulator may prohibit the bank from describing itself as an Islamic bank; and may even require the bank to close. Even if the banking regulator does not assess shariah compliance, which is the situation in the UK, once a bank fails to be shariah-compliant (for example if its Shariah Supervisory Board rules that it has failed to conduct its affairs in accordance with shariah), then it is likely to lose all customers who wish to use only an Islamic bank. However, if you are competing in the Islamic banking marketplace, every one of your competitors will, by definition, be a shariah-compliant Islamic bank. Accordingly, your being shariah-compliant conveys no competitive advantage; it is merely a foundation attribute. 9.14.10 The corporate banks Accordingly, the four corporate banks, BLME, EIIB, QIB and Gatehouse cannot distinguish themselves from each other by being shariah-compliant; they are all shariah-compliant. 9.14.11 Al Rayan Bank Al Rayan Bank is the only Islamic bank that the author is aware of in the UK that targets ordinary retail customers. (ADIB UK is different because it is focusing on serving customers of its parent company for their UK activities.)

146

U K’S ISLA MIC BA N K S

With the UK being a very immature retail Islamic finance market, Al Rayan’s homepage gives very prominent coverage to its shariah compliance and to educating visitors about the distinction between conventional banking and Islamic banking. That is because Al Rayan is not competing against other retail Islamic banks but rather seeking to create a retail Islamic finance market where none has existed before.

9.15 Future risks 9.15.1 Asset concentration All of the banks appear heavily focused on the financing of real estate transactions. To a large extent, this is a case of providing what the customer demands, since Muslim investors are typically heavily invested in real estate while being relatively less likely to invest in quoted shares. (This statement is of course a generalisation, albeit based on observation.) To some extent, the Islamic banks are behaving in a similar manner to conventional banks that are also often heavily involved in financing real estate transactions. That is why periods when real estate prices fall dramatically often result in distress for banks generally. However, in the author’s opinion the overconcentration on real estate is much more marked with Islamic banks than with conventional banks. Accordingly, they are heavily exposed in the event of a major fall in real estate prices. 9.15.2 The impact of departure from the EU The financial services sector in the UK is a significant exporter of services, many of which go to countries within the EU. The UK is presently negotiating with the EU what arrangements will apply after the transition period ends, which is likely to be 31 December 2020 since the UK government has stated categorically that it will not exercise its option to extend the transition period. At present, we do not know what arrangements will apply from 1 January 2021. However, current UK and EU statements lead the author to believe that UK-based financial services firms will have significantly reduced scope for providing financial services within the EU from that date onwards. In practice, this is likely to have a negligible impact on the UK’s Islamic banks. To the extent that their business is not domestic, it tends to be with customers located in the Middle East rather than with EU customers. More difficult to assess is the impact on the UK economy of departure from the EU. The best available forecasts from the Office for Budget Responsibility (a part of the UK government) suggest that the UK economy

147

M ohammed A min

will continue to grow but at a slower pace than it would have done if the UK had remained a full member of the single market, for example by remaining within the EU. If the forecast of continuing, albeit slower, growth proves accurate, then the negative implications of leaving the EU should be relatively minor for the UK’s Islamic banks. It would be much more problematic for them if the UK experiences a significant recession as that is likely to be associated with a fall in real estate values leading to the banks, especially the corporate banks, suffering credit losses.

9.16 Concluding comments As with everything else in this chapter, these concluding comments are based entirely upon reading the published accounts and drawing conclusions from them. 9.16.1 Poor planning It is obvious that there was some extremely poor project planning. For example, IBB in its original incarnation was simply undercapitalised. The author considers that it was entirely foreseeable that IBB would succeed in attracting deposits and that its small equity capital would constrain its ability to profitably lend out that money. That is exactly what happened. IBB made steady losses because it was unable to take on the risk of providing home purchase plans until after it was taken over and received a significant capital injection. Some of the other Islamic banks also look sub-scale and therefore virtually condemned to steadily lose money. 9.16.2 Poor execution A comparison of BLME and EIIB is illuminating. They were of roughly comparable size and initially had roughly similar strategies. BLME has indeed suffered some lending disasters that account for its losses. However, its management continuity and therefore related strategic continuity has enabled it to keep going through those difficulties. For a start-up operation in a new industry in a difficult commercial environment, its aggregate losses do not look unreasonable. Conversely, EIIB suffered regular changes in management associated with regular changes of strategy. The author considers that these are the reasons why it lost so much more money than did BLME.

148

U K’S ISLA MIC BA N K S

9.17 Looking forward The UK clearly has a real retail Islamic banking market, albeit a small one. IBB in its current format is now able to serve this market profitably. There appears little scope for a new entrant competitor, given the small size of the market and the proportionately prohibitive overhead costs that a small new bank must suffer. The corporate market appears to the author to be limited. Accordingly, it is difficult to forecast how the existing corporate Islamic banks will develop. As mentioned above, their lending appears dangerously overconcentrated in real estate. Despite some forays into asset management, the retail equity savings, pensions, and life insurance markets have so far received negligible attention. As with retail banking, the author considers that there is a real, albeit small, market for such services in the UK being provided in a shariahcompliant manner.

Notes 1 https://www.scribd.com/doc/43508142/Two-tier-Mudarabah-as-a-mode-ofIslamic-financial-Intermediation, accessed on 2 February 2020. 2 The Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2010; SI 2010 No. 86. 3 Finance Act 2005 sections 46–57 and Schedule 2. 4 https://www.alrayanbank.co.uk/media/411914/tolkein-prospectus.pdf, accessed on 26 February 2020.

149

10 INCLUSIVE AND SUSTAINABLE GROWTH WITH ISLAMIC FINANCE Salman Ahmed 10.1 Introduction The most distinct feature of the Islamic financial system is the absence of interest. Islamic law forbids riba just like all monotheistic faiths including Christianity and Judaism. This view on interest is taken up by all Abrahamic faiths and other distinguished scholars in history. Aristotle commented on interest as follows: “Of all modes of getting wealth, this is the most unnatural”. On the other hand, Thomas Aquinas said: “To take usury for money lent is unjust in itself, because this is to sell what does not exist and this evidently leads to inequality which is contrary to justice.” One of the stalwarts in modern macroeconomics, Keynes (1936) in his treatise “General Theory of Income, Employment, Interest and Money” stated: Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital. The term riba in Islamic finance refers to any stipulated premium, markup, or increase demanded over and above the principal amount of loan. Thus, the term riba incorporates usurious loans as well as modern-day interest in banking, debt markets, and contracts. Islam encourages striving for earning a livelihood through labor or productive enterprise. If the surplus wealth is invested in real productive enterprise, then the payoffs shall be shared equitably. This ensures distributive justice, employment of idle resources, and circulation of wealth through growing real sector economic activities. Islamic law does not guard capitalists with a fixed return on money capital to accumulate more wealth without bearing any potential loss in the 150

DOI: 10.4324/9781003050209-10

I NC LUSI V E A N D SUS TA I NA BL E GROW T H

commercial undertaking for which the loan was provided. Instead, Islamic law makes it necessary for money-capital owners to bear the risk of the productive enterprise to earn any legitimate growth in money capital. Islamic law permits profit on the trade of assets including consumer goods and capital goods if the seller has the ownership and risk of the goods prior to bringing them for selling to others. However, Islamic law does not permit earning money from lending money without undertaking risk in a productive enterprise. Excessive indebtedness in the conventional interest-based financial system is a major reason behind recurrent financial crises since growth is fueled by the debt economy (Buiter & Rahbari, 2015; Mian & Sufi, 2015). When the real economy is no longer able to service excessive levels of debt, it causes debt instruments to default on the cash flow commitments and creates panic selling, which multiplies once triggered. Secondly, Islam emphasizes transparency in relations and economic exchanges. In the financial contracts, Islam emphasizes transparency, full disclosures, rules abidance, justice, truthfulness, and excellence in conduct, both in letter and spirit. Islamic principles prohibit gharar (uncertainty) in a transaction that leads to significant losses down the road due to misinformation about price, delivery, quantity, quality, or specification of the subject matter. Islam also forbids maysir (gambling) for its negative effects on distributive justice as well as on the moral standards of earning a livelihood. Thus, conventional insurance, financial derivatives, and convertible securities are not permissible in Islamic finance. Takaful is an Islamic substitute for conventional insurance. Conventional insurance includes the element of interest-based investments as well as maysir (gambling) since the payoffs are contingent on some future probabilistic events. Takaful avoids the element of interest by only resorting to investments that are permissible in Islamic law and which avoid riba (interest), maysir (gambling), and gharar (uncertainty). In takaful, rather than paying premiums to a company, the clients contribute to a pooled fund overseen by a manager, and they receive any profits from the fund’s investments. Hence, takaful is based on the concept of mutual cooperation and shared responsibility. Finally, Islamic social finance comprises institutions that aim to perform the redistributive function by wealth and asset reallocation from the rich to the poor, from the haves to the have-nots, from the wealthy to the deserving people through institutions, such as zakat (a wealth tax on people owning wealth above a threshold amount known as nisab) and waqf (Islamic endowments). These Islamic social finance institutions provide financial services and assistance to clients who are not able to access credit services from the banks. In real-estate waqf, rental can be generated, which can be employed for the social upliftment of the poor and to fund socially desirable projects. Cash waqf can be utilized to provide immediate assistance to the poor for 151

S alman A hmed

Islamic Finance

Islamic Commercial Finance

Islamic Banks

Takaful

Islamic Social Finance

Islamic Investment Funds

Zakat

Waqf

Sukuk

Figure 10.1 Islamic Financial System.

consumption as well as small business investments. Thus, we see that the Islamic finance ecosystem has sufficient institutions as rules and product structures to meet contemporary financial needs responsibly and ethically in line with Islamic principles. Figure 10.1 shows the major institutions in the Islamic financial system. Islamic finance can be divided into commercial and social finance which together cater to the needs of all the broad sections of the society.

10.2 Economic value proposition of Islamic finance Financial institutions enable savers and investors to invest and obtain finance. They provide delegated monitoring and portfolio management services in an efficient way (Diamond, 1984). In a direct potential exchange between saving surplus and saving deficient units, there is a double coincidence problem in terms of matching cash flow needs and availability and the preference for maturity in investment and financing. Unlike in spot exchange, information asymmetry between the counterparties in an intertemporal exchange of funds requires diligent monitoring and enforcement of contract terms. Financial institutions provide intermediation services to reduce these transaction costs for both the counterparties. From the Islamic viewpoint, the critical element is that the intertemporal exchange of funds shall not be including any increase over the principal amount of loan. There are two alternatives to meet this restriction. One alternative is that if a money loan is provided, then no increase over the principal amount is charged. The second option is to provide financing for the acquisition of an asset by either selling it or providing it on lease. In both cases, the financial institution has to own, possess, and bear the risk of 152

I NC LUSI V E A N D SUS TA I NA BL E GROW T H

asset in possession before selling it or providing it on lease. In such a way of financing, the Islamic financial institution can earn profit on credit sale or earn rents on providing the usufruct of asset in its ownership to the client.

10.3 The flow of funds in the interest-free asset market Equity financing is closest to the spirit and ideal of Islam where the risk of the enterprise is shared among the partners. Thus, every partner’s payoffs are linked with the outcome of the enterprise. Since there is no financial cost of funds, the residual profit is shared among the partners equitably through a mutually agreed profit-sharing ratio. In the costing for products and services in mudarabah- and musharakah-funded enterprises, interest cost does not feature and hence, the prices are not increased in anticipation of bearing the cost of interest. From the perspective of income distribution and social co-operative behavior, mudarabah and musharakah are ideal modes of financing since financial returns for both sets of partners are directly linked with the real sector of the economy. Therefore, there is less pressure on markets to produce and sell extra levels of output to service the fixed cost of debt. Thus, more penetration of this mode of financing could stabilize business cycles and avoid crises that are quite common in contemporary interest-based financial markets. In making investments, consumers forgo present consumption for possibly higher future consumption. In light of economic theory and empirical evidence in both mainstream and behavioral finance literature, the number of investments they make would depend on their: Marginal rate of substitution between current and future consumption. Reward to variability ratio of the investment undertaking. Degree of loss aversion in preferences. They will reveal their preferences by responding in terms of making different levels of capital investments at different levels of profit-sharing ratio. Steep indifference curves, i.e. higher marginal rate of substitution for intertemporal consumption and loss aversion would make them demand a higher profit-sharing ratio for themselves. On the other hand, a higher Sharpe ratio (i.e. higher reward to variability) of a potential investment undertaking would enable them to reap the target level of return even with a lower profit-sharing ratio. In addition to that, in an economy there are individuals or groups of individuals who would be looking to pursue productive investments, but remain short of funds. Such individuals would require capital investments. In return, they would offer profit-sharing in the investment undertaking. As is usually the case, the ex-ante profit-sharing ratio is offered by saving deficient 153

S alman A hmed

units looking to source finance. The factors that determine this offered profit-sharing ratio include: Amount of capital needed. Duration of investment. Reward to variability ratio of the investment undertaking. The greater the capital requirement and the duration of investment undertaking, the higher will be the offered profit-sharing ratio. However, the higher the reward to variability ratio, the lower will be the offered profitsharing ratio. Unlike debt-based financing where the savers and investors have the opposite reaction to the rate of return since the return for savers is the cost to investors, the interest-free equity financing based capital markets do not have an inherent tension between savings and investments. Both react uniformly to the internal strength of the investment undertaking, i.e. reward to variability ratio. Since there is no fixed return to money capital alone in the investable funds market, all savings must necessarily be invested in the real economy to earn any return. If no return is required, then surplus savings can be either paid to charity or given as an interest-free loan. Any return on investments will have to be earned in the real economy. The equilibrium is shown in Figure 10.2 where the horizontal line represents the saving deficient units’ demand for capital investments, whereas, the upward sloping line illustrates the saving surplus units’ supply of investable funds at different levels of profit-sharing ratios. Equilibrium occurs at the equilibrium profit-sharing ratio; the amount of capital invested by the investors equals the capital investment required by the firm. The higher the capital requirement, the longer the duration of investment and the lower Sharpe ratio will compel the firms to offer a higher profitsharing ratio and vice versa. Figures 10.3 and 10.4 show both the downward and upward shifts in SDU investment demand curves.

Profit Sharing Ratio

Interest Free Asset Market 0.8 0.6 0.4 0.2 0

0

100

200

300

400

500

600

Capital Investment (mln Rs.) SSU (Investors)

SDU (Firms)

Figure 10.2 Equilibrium in the Interest-Free Asset Market.

154

700

I NC LUSI V E A N D SUS TA I NA BL E GROW T H

Interest Free Asset Market

Profit Sharing Ratio

0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

0

100

200

300

400

500

600

700

Capital Investment (mln Rs.) SDU (Firms)

SSU (Investors)

SDU' (Firms)

Figure 10.3 Downward Shift in the SDU Curve.

Interest Free Asset Market

Profit Sharing Ratio

0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 0

100

200

300

400

500

600

700

Capital Investment (mln Rs.) SSU (Investors)

SDU (Firms)

SDU' (Firms)

Figure 10.4 Upward Shift in the SDU Curve.

An increase in the Sharpe ratio of an investment indicating greater strength of the project will shift the SDU curve down as well as shift the SSU curve to the right. Thus, firms sourcing funds can source the required funds at a lower profit-sharing ratio as the SSU curve becomes flatter and shifts to the right following an increase in the Sharpe ratio. On the other hand, the increasing impatience of consumers would make their indifference curves steeper and hence shift the SSU curve to the left. Furthermore, a higher loss aversion would also result in the SSU curve becoming steeper. As a result, firms will have to respond by increasing the profit-sharing ratio for involving extremely patient and loss-averse consumers to engage in capital investments. Figures 10.5 and 10.6 show both the rightward and leftward shifts in SSU investment supply curves. 155

S alman A hmed

Profit Sharing Ratio

Interest Free Asset Market 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 0

100

200

300

400

500

600

700

Capital Investment (mln Rs.) SSU (Investors)

SDU (Firms)

SSU' (Investors)

SDU' (Firms)

Figure 10.5 Rightward Shift in the SSU Curve.

Profit Sharing Ratio

Interest Free Asset Market 1 0.8 0.6 0.4 0.2 0 0

100

200

300

400

500

600

700

Capital Investment (mln Rs.) SSU (Investors)

SDU (Firms)

SSU' (Investors)

SDU' (Firms)

Figure 10.6 Leftward Shift in the SSU Curve.

Thus, the preceding analysis shows that movement in the profit-sharing ratio can perform the asset allocation function in the interest-free capital market. Furthermore, investment acceleration can be achieved through institutionalizing zakat, which levies a charge on idle wealth. In an economy where there is prohibition of interest, the surplus and idle wealth would accelerate the conversion of savings into investment. Thus, it can enhance the scale of decent employment opportunities and contribute to economic growth. Even those savers who would not like to directly invest in stocks of new start-ups or small companies will invest through financial intermediaries like banks and mutual funds to minimize their risk by diversification and effective asset reallocation by skillful fund managers who could monitor the performance more effectively and efficiently on investors’ behalf. 156

I NC LUSI V E A N D SUS TA I NA BL E GROW T H

In addition, since there is no return on money balances and direct participation possibilities in the investment projects through asset markets, there will be a lower risk for the economy to fall in a liquidity trap. Haque and Mirakhor (1986) show that due to no compulsion of paying interest as a cost, the rate of return to both saving surplus units and saving deficient units from the productive enterprise will increase and will result in an increase in aggregate savings. Due to the prohibition of interest, these savings will be converted into investments and will contribute to employment generation rather than sitting idle and earning a stipulated increase. The effects of the Islamic capital market operations on the macro economy are very positive. There is less pressure on the current account balance if there is negligible or limited gap between savings and investments. In an open market economy, the gap between savings and investments is filled by the current account balance. Thus, a stable current account can have a stabilizing effect on the exchange rate and on domestic currency as a store of value in the interest-free economy. In an empirical study of 15 countries with a majority of Muslims, it has been found that money supply that does not earn interest is more stable than money supply that earns interest (Hassan & Aldayel, 1988).

10.4 Islamic banking for short-term financing and investments Islamic banking enables short-term intertemporal finance between riskaverse investors and individual and corporate clients who require shortterm finance. Risk-averse investors want to minimize risk and delegate the responsibility of credit-portfolio monitoring to Islamic banks. There are certain short-term finance needs that might be difficult to finance through long-term equity finance or which can be more efficiently funded through employing trade- and lease-based modes of financing. Interest-free Islamic banking primarily caters to short-term finance needs involving an asset and the investor client base of Islamic banks are investors who want to smooth the path of consumption through regular incomes with limited chances of risk. Thus, Islamic banking investments are suitable for impatient, riskaverse, and loss-averse investors who invest in a limited way by sharing in the financing of real assets where the returns are linked to the asset’s sale or use rather than their long-term productivity. The basic operation of Islamic banking involves deposit mobilization in the form of qard (for non-return-earning deposits) and mudarabah (for returnearning deposits). Then, the asset pool is created in which the bank invests its equity capital as well as the deposited funds of the depositors. There is no return earned by the investors keeping non-remunerative accounts with the Islamic bank. The depositors in non-remunerative accounts only benefit from the safekeeping of deposits and making and receiving payments 157

S alman A hmed

through the banking channel. On the other hand, there is a return earned by the investors keeping remunerative accounts with the Islamic bank. The bank utilizes the funds in the asset pool to provide asset-backed financing. Asset-backed financing consists of various financing assets based on different underlying financing contracts, i.e. ijarah, diminishing musharakah, murabaha, salam, and istisna. Islamic banks earn their income either through a cost-plus-markup sale in credit sale based modes of financing or earn rentals in lease-based modes of financing. These returns are then shared among the investors. Most capital-intensive businesses require the purchase of industrial machinery and equipment. With the advancement in technology, it is necessary to invest in physical capital goods from time to time to remain competitive and efficient. Islamic banking enables infrastructure investments and expansion in productive capacity for the businesses through the provision of trade and lease-based finance of real assets rather than loaning out money on interest. These checks financial leverage. It also supports operating leverage since investment in fixed assets through Islamic banking is by way of trade and lease-based finance. In Islamic lease-based finance, the rentals are obligatory only during the time of lease, which only starts after the asset is delivered in a usable form. According to the Global Islamic Finance Report 2018, global Islamic finance assets reached $2.4 trillion in 2017 (Global Islamic Finance Report, 2018). Table 10.1 gives a snapshot of growth in Islamic banking and Islamic finance since 2012. As much as 71% of the global Islamic financial assets are held by Islamic banks and conventional banks with Islamic banking windows. The total Islamic banks and Islamic windows operating globally had reached 505 in 2017, according to Thomson Reuters Global Islamic Finance Report 2018. Table 10.2 presents the share of different countries in global Islamic banking assets. In more recent years, Islamic finance industry assets grew by a CAGR of 6% to $2.44 trillion in 2017 as compared with 2012. Quarterly panel data from 2013 to 2018Q1 in Table 10.3 reveal that the profitability of Islamic Table 10.1 Growth in Islamic Banking and Finance (2012–2017) Year

Islamic Banking Assets ($Billion)

Islamic Finance Assets ($Billion)

2012 2013 2014 2015 2016 2017 2023

1,305 1,565 1,445 1,604 1,675 1,721 2,441

1,746 2,050 1,965 2,190 2,290 2,438 3,809

Source: Thomson Reuters Global Islamic Finance Report 2018.

158

I NC LUSI V E A N D SUS TA I NA BL E GROW T H

Table 10.2 Share of Countries in Global Islamic Banking Assets Country

Share in Global Islamic Banking Assets (%)

Iran Saudi Arabia UAE Malaysia Qatar Kuwait Turkey Bangladesh Indonesia Bahrain Sudan Pakistan Egypt Jordan Oman Brunei Others

34.40 20.40 9.30 9.10 6.00 6.00 2.60 1.90 1.80 1.70 1.60 1.20 0.80 0.70 0.60 0.50 1.40

Source: Islamic Financial Services Industry Stability Report 2018.

Table 10.3 Islamic Banking Indicators Globally Country/ Indicators

CAR (%)

GNPF (%)

ROA (%)

ROE (%)

NPM (%)

C to I (%)

LA to TA (%)

Bahrain Brunei Egypt Indonesia Jordan Kuwait Malaysia Nigeria Oman Pakistan KSA Sudan Turkey UAE

19.0 21.2 13.5 15.7 22.3 18.0 15.7 38.3 40.7 14.1 20.3 18.7 15.5 16.5

12.1 5.7 7.6 4.7 3.0 3.0 1.3 1.7 0.1 6.0 1.2 6.0 4.3 7.9

1.3 1.7 2.7 0.9 1.7 1.2 1.1 0.1 −2.0 1.0 2.1 2.6 1.1 1.5

9.8 12.3 47.9 9.4 17.9 10.3 15.2 0.7 −3.4 15.9 14.4 25.7 12.4 12.6

26.5 52.4 59.2 9.0 48.3 21.4 39.4 4.9 −71.0 24.6 47.7 52.9 18.7 33.9

82.3 40.5 31.5 91.1 51.7 36.7 41.6 89.9 158.2 74.8 52.0 43.8 49.3 66.2

17.6 49.9 68.4 12.9 36.7 32.0 11.2 21.1 20.4 30.7 26.3 37.1 48.7 15.0

Source: Author’s calculations from IFSB data.

banks has been generally impressive. Furthermore, in Brunei, Egypt, Kuwait, Malaysia, Sudan, and Turkey, the cost to income ratio is below 50%. Except in Bahrain, the gross non-performing finance ratio is lower than 10% in all countries. Finally, the capital adequacy ratio on average is greater than 13% in all countries. In Table 10.3, CAR represents capital adequacy ratio, GNPF represents gross non-performing financing (% of Financing), 159

S alman A hmed

ROA represents return on assets, ROE represents return on equity, NPM represents net profit margin, C to I represents cost to income ratio, and LA to TA represents liquid assets to total assets ratio. There is a significant potential for further growth in enabling financial inclusion in developing countries with a majority of Muslims since a significant number of people do not hold bank accounts for religious reasons in such countries (Demirgüç-Kunt et  al., 2014; Naceur, 2017). Moreover, sub-Saharan Africa accounts for less than 2% of the Islamic finance assets globally even though the continent’s Muslim population is 250 million and according to the World Bank, as many as 350 million Africans do not have a bank account (The Economist, 2017).

10.5 Islamic finance and inclusive economic growth The permissibility of earning interest on the amount of money lent creates distributive inequity in the financial flows as well as delinks the financial flows from the real economy. Tremendous financial investments in exotic financial derivatives and money markets ensure return to the financial capitalist on fiat money without having any commitment to give back to society any tangible real benefit. The current financial system largely funds rich segments of the population who can provide collateral as security for the grant of money-based loans. In a market following Islamic norms and values, the market forces will determine which halal goods and services should be produced and offered at what price. Through private sector investment and production, resource markets and product markets will function to enable households to obtain purchasing power by providing rentable factors of production like labor services (ijarat-ul-ashkhas) or usufruct of a naturally existing or produced tangible asset (ijarat-ul-a’yan) in the production process and earn compensation in terms of wage and rent, respectively. As per Islamic rules of trade, the subject matter should be halal and the price once determined cannot be changed in a credit sale after the sale is executed. Since contemporary businesses require expensive and long duration capital goods for achieving efficiency and economies of scale, sourcing capital from individual households having surplus investable capital might be cumbersome. Islamic banks exist to reduce transaction cost, mitigate moral hazard, and provide asset-backed financing. Islamic banks monitor the investments made by households and share the profits on investments with them. Since there is no provision of earning money by simply loaning fiat money, all the financing provided is backed by real assets in the Islamic economic framework. This mitigates the moral hazard problem and the misuse of funds. It also ensures that the real assets are traded or leased when a financing contract is executed. Thus, it strengthens the link with the real economy 160

I NC LUSI V E A N D SUS TA I NA BL E GROW T H

and links the payoffs with the outcome of real economic transactions rather than fixating profit for one party in investments. By ensuring that financial intermediaries cannot simply earn interest on money capital alone, they necessarily have to ensure that they provide asset-backed financing and these assets are purchased from the resource markets (such as raw materials, equipment, and machinery) or goods market (such as cars and consumer appliances). Finally, the institution of zakat ensures that the poor and hungry people who earn below subsistence-level incomes are provided with income support so that they can fulfil their basic needs. Producers and rich households who are required to pay zakat, ushr, and khums share their incomes with the poor households. Thus, the Islamic economic framework ensures that investable capital is invested in the real economy, and through which, a greater magnitude of employment opportunities are created as against an interest-based financial system in which the funds can be invested in financial derivatives and money markets to earn a risk-free return. Finally, those households that remain unable to earn sufficient incomes to meet their needs are supported through the second phase of circulation of endowments, which is not based on the profit motive, but which is driven by pure altruism. Figure 10.7 shows the Islamic economic framework in which the dashed lines represent monetary flows and the solid lines represent the commodity flows. Hasan (2006) highlights a potential problem of trade-off between economic growth and environmental concerns. An apprehension is that containing consumerism and excessive use of natural resources and carbon-based Wages and Rent paid for the use of assets and services Price and Rents Paid on Asset Backed Finance Asset Backed Financing Capital Goods Firms

Ashkhas & A’yan Zakat, Ushr, Khums

Mudarbah Profits Investment Capital

Islamic Bank Price Paid Asset Sold Resource Market Government

Ijarat-ul-A’yan, Ijaratul-Ashkhas Zakat Paid to Fuqura, Masakin

Households

Zakat Paid by Sahib-ul-Maal Goods and Services

Goods Market Asset Sold Islamic Bank

Goods and Services Price Paid Asset Backed Financing

Price and Rents Paid on Asset Backed Finance

Price paid for the consumption goods.

Figure 10.7 Islamic Banks in Inclusive Islamic Economics Framework.

161

S alman A hmed

fuels might lower economic activities and economic growth. Islamic banking has to ensure that it offers financing for investment in green technology for business process engineering in the industrial production process. Simultaneously, Islamic banks by their very nature engage in real sector economic activities through asset-backed financing and hence, Islamic banks do not have any option of lending money for interest. This can ensure the availability of finance where needed to keep the real economic activities going while doing away with clean lending to discourage consumption on non-durable goods, which puts more stress on environmental and food resources. Furthermore, Islamic values emphasize on avoiding luxurious consumption and encourage distribution through zakat, qard-e-hasan, infaq, and waqf to ensure that endowment-deficient households are also able to meet their essential needs. Lastly, faith-compliant investments use ethical filters to avoid provision, production, and consumption of impermissible goods and services. Such goods and services contain spiritual and social ills and are also unnecessary: For instance, goods and services provided by casinos, liquor shops, night clubs, prostitution, PG-rated visual content, and so on. Thus, it naturally compels faith-conscious investors to look toward investments in the real sector of the economy. Thus, faith-conscious investors are expected to be more open and attracted toward extra filters in environmental, social, and governance (ESG) criteria and impact investments. Table 10.4 lists how Islamic modes of financing can stimulate various components of aggregate demand in the economy. An increase in aggregate demand can spur growth. Since the benefits of enterprise through Islamic finance are shared mutually and are derived from activities in the real sector of the economy, the distributional effects of such financing modes and mechanisms are also qualitatively different and more egalitarian as compared with conventional banking where conventional banks can park and Table 10.4 Aggregate Demand Stimulants in Islamic Finance Components of Aggregate Demand

Islamic Modes of Financing Used

Consumption

Murabaha and musawamah for short-term financing Ijarah for long-term durable goods finance Murabaha and salam for short-term financing Ijarah and diminishing musharakah for long-term financing Sukuk based on the above structures if financial markets are approached Sukuk based on ijarah, istisna, mudarabah, and musharakah structure Murabaha, salam, and istisna for raw materials finance and ijarah and diminishing musharakah for long-term fixed assets finance

Investment

Government expenditure Net exports

162

I NC LUSI V E A N D SUS TA I NA BL E GROW T H

invest their major chunk of liquidity with banks and financial institutions in the money market and earn money on money by investing in money-based financial securities. In economic growth literature, several models have been developed mathematically and tested empirically. Some of the well-known models include Harrod (1939)–Domar (1946) Model, Solow’s (1956) Growth Model, and Endogenous Growth Model by Romer (1994). In these models, the emphasis is put on increase in savings, investment, human capital, technological advances, and social infrastructure. In discussing the Islamic perspective on the insights of these models, it is important to know that savings have to be invested to ensure capital formation and kick-start economic growth. A recent Japanese example is a testimony to the fact that merely having a high savings ratio is not enough for a sustainable high growth rate. Thus, what leads to growth is investment. Islamic principles encourage savings and to invest savings directly in the real economy to achieve capital formation and increase in productivity. Islamic finance does not give any chance for idle savings to earn any return from the production process. In fact, by levying zakat on idle savings, Islamic finance principles encourage circulation of idle resources to productive uses. Thus, in an Islamic economic framework, there is expected to be higher levels of savings, and Islamic finance channels these savings directly in the real economy since there is no mechanism to earn money on money through the lending of money in an Islamic framework. Secondly, the equity-based modes of financing like mudarabah encourage investment in ideas by providing capital support to enterprising individuals with budding business ideas. Using Islamic capital markets, sukuk-based financing by the government can ensure adequate supply of both public infrastructure as well as infrastructure for education and health to boost the supply and effectiveness of physical and human capital. In Islamic capital markets, sukuk is a certificate that represents the proportionate ownership in the underlying asset. The underlying physical asset can be financed using Islamic trade and leasebased modes of financing. The funding for the asset comes from issuing participation certificates (i.e. sukuk) to the investors. The returns on these assets come in the form of profit on sale or rentals on the use of the assets, which are paid by the issuer of sukuk. On the other hand, Islamic modes of financing enable the firms to invest in technology and engage in technological up-gradation in their production processes to enhance the level of productivity.

10.6 Islamic finance and sustainable economic growth The concept of sustainable growth and development is not new to Islam. The five grand objectives in Islamic framework (maqasid-e-shari’ah) emphasize on safeguarding economic wealth (hifz-ul-māl), ensuring sustainability 163

S alman A hmed

(hifz-ul-nasl), building human capital and well-being through education and health (hifz-ul-aql and hifz-un-nafs), and nurturing social capital and social infrastructure through a permanent and objective set of values and ethics (hifz-ud-deen). In the mainstream economic literature, the importance of human capital and environmental sustainability has been realized in the West much later. Nonetheless, these are the focal aspects of any policymaking and institutional design in the Islamic framework. Table 10.5 illustrates how Islamic values, institutions, and instruments can help in contributing toward achieving each of the sustainable development goals. For social finance needs, zakat, waqf, and qard-e-hasan are effective institutions. For asset finance in infrastructure projects, direct finance by way of murabaha, ijarah, and diminishing musharakah and indirect finance through securitization via sukuk is possible. Equity-based modes of financing like mudarabah and musharakah can promote inclusive finance. Redistributive institutions like zakat and the principle that monetary debts are to be paid in the same amount without stipulated increase (riba) can check wealth concentration and inequality. On the other hand, values, norms, and ethics can help in transforming lifestyles and promote cooperation through goodwill. Religion can positively contribute in sustainable development through the values it offers and through its potential for ecological, social, and political activism (Narayanan, 2013). Islamic values could play a role in shaping preferences and attitudes toward avoiding waste and ensuring recycling and responsible use of resources. The concept of tawheed helps humans understand horizontal equity among all forms of life since every one of the single species is created by Allah. The concept of khilafah, which is unique to humans informs them that they are custodians of resources they possess, own, and over which they have control. The eco-system has evolved over billions of years sustaining life including that of humans. Thus, protection, preservation, restraint, and responsibility in attitudes and behavior require long-term perspectives to envision sustainable ecosystems for ensuring sustainable living for humans at present, and a sustainable future for all life (Tucker, 2008). Thus, the concept of divine accountability and absolute justice in the afterlife induces responsible behavior in the face of accountability of actions and intentions. The alternate option of market-based intervention to contain environmental damage is less than effective. Environmental levies have a less significant impact on reducing environmental pollution. First, the cost to environment is hard to measure. Hence, negative externalities are in most cases not easy to measure and attribute to the right source of cause to the extent of the social cost of negative externality. Second, if these levies become part of

164

I NC LUSI V E A N D SUS TA I NA BL E GROW T H

Table 10.5 Use of Islamic Finance in Sustainable Development Goals #

Sustainable Development Goals

1

No poverty

2 3 4 5

6 7 8 9 10 11

12 13

14 15

16

17

Methods of Intervention in Islamic Economic Framework

Zakat, waqf, qard-e-hasan, mudarabah, salam Zero hunger Zakat, waqf, qard-e-hasan Good health and well-being Waqf, takaful, qard-e-hasan Quality education Waqf, takaful, qard-e-hasan Gender equality Islamic socio-ethical values providing property rights to women, financial sustenance in a marital relationship, and freedom to engage in any halal business or financing contract Clean water and sanitation Ijarah sukuk, istisna sukuk, waqf Affordable and clean energy Ijarah sukuk, istisna sukuk Decent work and economic Islamic trade (murabaha, salam, istisna), growth lease (ijarah, musharakah mutanaqisa Industry, innovation and and participation-based modes infrastructure financing (mudarabah, musharakah) Reduced inequality Zakat, waqf, qard-e-hasan, mudarabah, musharakah Sustainable cities and Takaful and using Islamic trade communities (murabaha, salam, istisna), lease (ijarah, musharakah mutanaqisa, and participation-based modes financing (mudarabah, musharakah) Responsible consumption and Islamic socio-ethical values encouraging production moderation, conservation, and avoiding wastefulness Climate action Islamic socio-ethical values. Financing through markets via sukuk or via intermediaries by using Islamic trade and lease-based modes of financing Life below water Islamic socio-ethical values encouraging cleanliness and discouraging wastefulness Life on land Islamic socio-ethical values encouraging conservation, moderation, and avoiding wastefulness and harm to other living beings in the eco-system Peace and justice strong Islamic socio-ethical values prioritizing institutions justice, rule of law, banning harm to other’s property, life and honor, and penalizing offenses Partnerships to achieve the goal Concept of ta’awun al-al birr (mutual cooperation in goodness) and promoting maslaha (welfare)

165

S alman A hmed

private marginal costs, then, in most industries, they would be transferred in output price where the demand is inelastic. In other industries, it might lead to a reduction in production, and hence employment and income, if the demand is elastic. In such cases, values play a significant role in creating a culture where humans in their individual capacities as part of society and community adhere to values, norms, and ethical principles in all walks and roles of life as consumers, producers, policymakers, or investors. On the other hand, Islamic finance could allow investments in technology that can foster efficiency in the use of finite resources and the use of renewable resources in the production process. Industrial production processes are required to be transformed from linear to circular systems through recycling and avoiding waste. This requires investment in green technology for business process engineering. This need for investments in fixed assets can be financed through ijarah, diminishing musharakah, and sukuk as well if firms want to tap capital markets. Asset-backed financing is also conducive in public finance where the requirement for financing is huge and the duration of financing is also long-term. Finally, Islamic social finance through qard-e-hasan, zakat, and waqf could ensure that the resources flow even to those who are not able to earn incomes for meeting their needs from the resource markets due to a lack of skills and inadequate health and education. The ban on interest and selling of debt on premium would allow the liquidity in the financial system to be utilized in the real economy. Thus, it can be seen that there is ample potential in the Islamic finance ecosystem to contribute to financing the required resources for sustainable development. Islamic Development Bank is optimistic that Islamic finance instruments can be employed in water and sanitation projects, energy projects, and infrastructure projects (Hussain, 2019). On the other hand, human capital development is also necessary for inclusive growth. Those poor people who are unable to generate income in the market economy due to a shortage of funds can be financed through equity-based modes of financing to ensure inclusivity and socio-economic mobility. In classical and neoclassical growth theories, it is contended that income inequality is unavoidable and is needed to trigger economic growth. In the Lewis structural model (1954), capitalists are expected to move production in the modern manufacturing sector in urban areas to instigate economic growth. Kuznets (1955) promised that economic growth will eventually trickle down to poor people. However, even sustained economic growth did not result in equitable distribution of income as the recent evidence suggests and as documented meticulously by Piketty (2014). Inclusive finance requires the provision of capital on the basis of equity rather than exorbitantly expensive interest-based microfinance. The interest-based microfinance only raises the cost of capital for the lack of availability of collateral. Hence, it does not result in inclusivity and thus 166

I NC LUSI V E A N D SUS TA I NA BL E GROW T H

regions that have higher penetration of microfinance still have higher rates of poverty. Whatever decrease in poverty has occurred, it is due to the increase in economic growth rates, such as in China, Cambodia, Vietnam, and Bangladesh. Islamic equity-based modes of financing like mudarabah and musharakah ensure that ideas and human capital are provided with financial capital on profit- and loss-sharing bases so that these ideas and human capital have a greater chance of achieving socio-economic mobility. This is unlike the case in interest-based microfinance where the cost of debt is higher and the repayment terms are of shorter duration. Lastly, the values of cooperation (ta’awun), brotherhood (akhuwwa), together with accountability (hisba), give a boost to social capital. Islamic social finance through zakat and waqf caters to the development needs indigenously through a redistribution of resources from the haves to the havenots without having to resort to interest-based debts.

10.7 Conclusion This chapter discussed that there is ample flexibility and enriched product line in Islamic banking and finance to cater to diverse needs for achieving inclusive and sustainable economic growth. The macroeconomic interlinkages with Islamic banking operations are direct, transparent, and support stability in the economy. Real sector based productive enterprises can contribute toward full employment of resources and inclusive growth. The development finance needs can also be dealt with through Islamic social and commercial financial institutions and instruments. Prohibition of earning risk-free returns on lending within the Islamic framework allows greater attention to investments in the real economy to increase capital formation and entrepreneurship. Islamic modes of financing can boost aggregate demand components including consumption, private sector investment, and public sector investment. On the other hand, Islamic equity-based modes of financing and social finance ensure inclusiveness and socio-economic mobility of the poor people who remain excluded from finance in the current financial system due to a lack of collateral for monetary loans.

References Buiter, W. H., & Rahbari, E. (2015). “Why Economists (and Economies) Should Love Islamic Finance”, Journal of King Abdulaziz University: Islamic Economics, 28(1), pp. 139–162. Demirguc-Kunt, A., Klapper, L., & Randall, D. (2014). Islamic finance and financial inclusion: measuring use of and demand for formal financial services among Muslim adults. Review of Middle East Economics and Finance, 10(2), pp. 177–218. Diamond, D. W. (1984). “Financial Intermediation as Delegated Monitoring: A Simple Example”, Review of Economic Studies, 51(3), pp. 393–414.

167

S alman A hmed

Domar, E. (1946). “Capital Expansion, Rate of Growth, and Employment”, Econometrica, 14(2), pp. 137–147. Global Islamic Finance Report (2018). Global Islamic Finance Report. London: Edbiz Consulting Group. Haque, N. & Mirakhor, A. (1986). “Saving Behaviour in an Economy without Fixed Interest”. Discussion Paper, Development and Research Department, Economics and Research Staff, Report No. DRD184. Harrod, R. F. (1939). “An Essay in Dynamic Theory”, The Economic Journal, 49(193), pp. 14–33. Hasan, Z. (2006). “Sustainable Development from an Islamic Perspective: Meaning, Implications, and Policy Concerns”, Journal of King Abdulaziz University: Islamic Economics, 19(1), pp. 3–18. Hassan, M. K., & Aldayel, A. Q. (1998). “Stability of Money Demand under Interest-Free Versus Interest-Based Banking System”, Humanomics, 14(4), pp. 166–185. Hussain, Y. (2019). “Role of Islamic Finance in Achieving Sustainable Development Goals”. Journal of Islamic Thought and Civilization, 5(1), pp. 46–55. Keynes, J. M. (1936). Theory of Income, Employment, Interest & Money. New York: Polygraphic Company of America. Kuznets, S. (1955). “Economic Growth and Income Inequality”, The American Economic Review, 45(1), pp. 1–28. Lewis, W. A. (1954). “Economic Development with Unlimited Supplies of Labour”, The Manchester School, 22(2), pp. 139–191. Mian, A., & Sufi, A. (2015). House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again. Chicago, IL: University of Chicago Press. Naceur, S. B., Barajas, A., & Massara, A. (2017). “Can Islamic Banking Increase Financial Inclusion?” In Handbook of Empirical Research on Islam and Economic Life. Cheltenham: Edward Elgar Publishing. Originally published in IMF Working Chapter, WP/15/31-(2015). Narayanan, Y. (2013). “Religion and Sustainable Development: Analysing the Connections”, Sustainable Development, 21(2), pp. 131–139. Piketty, T. (2014). Capital in the Twenty-first Century. New York: Harvard University Press. Romer, P. M. (1994). “The Origins of Endogenous Growth”, Journal of Economic perspectives, 8(1), pp. 3–22. Solow, R. M. (1956). “A Contribution to the Theory of Economic Growth”, Quarterly Journal of Economics, 70(1), pp. 65–94. The Economist (2017). “Africa is Islamic Banking’s New Frontier”, Print Edition, July 13, 2017. Tucker, M. E. (2008). “World Religions, the Earth Charter, and Sustainability”. Worldviews: Global Religions, Culture, and Ecology, 12(2–3), pp. 115–128.

168

11 EMBRACING ISLAMIC BANKING AS A NEW ENGINE TOWARD ECONOMIC GROWTH Syed Muhammad Abdul Rehman Shah, Muhammad Umar Farooq, and Muhammad Akmal 11.1 Introduction In the wake of the financial crisis of 2007, there appear various debates among economists about the need for a new development model leading to inclusive economic growth. Is Islamic banking the answer? Indeed, Islamic banking appears with two inherent characteristics: risk-sharing and asset-backed financing arrangements that develop the link between nominal and the real sector of the economy. This clarity of contractual obligations leads to the soundness of the system, including financial regulators, products, institutions, and structure of markets, and tends to make the whole financial environment more flexible against surprising shocks. As a result, this critical link conveys stability to the financial system, endorses equitybased market relative to debt financing, controls vulnerability, eradicates poverty through employment, and leads overall to sustainable development and inclusive economic growth. Mansor et al. (2019) have found that Islamic mutual funds performed better than conventional mutual funds during these global crises. The role of the financial sector is very important in accelerating economic growth. These financial institutes are supposed to provide resources to economic agents who are facing shortage or excess of funds as financial intermediations (Herwartz and Walle, 2014; Jedidia et al., 2014; Durusu, et al., 2017; Fuinhas, et al. 2017 and Nosheen and Rashid 2019). When the financial sector is more advanced, more physical capital can be accumulated and distributed to accelerate economic growth with optimal allocation. King and Levine (1993) using panel data of 80 countries document a strong and positive link among financial development and per capita output. Being a part of the financial system, Islamic financing system also affects economic growth. Further, the impact of the financial system on economic growth is not found; rather, it depends consistently on the level of growth of an economic system, structure of financial methods, legal system, financial inclusion, and the overall quality of organizations. So many forthcoming issues DOI: 10.4324/9781003050209-11169

SYED MUHAMMAD ABDUL REHMAN SHAH ET AL.

and promising avenues are there for upcoming research with regard to sustainable inclusive economic growth. The global Islamic financial market is mounting temperately due to the huge investments in the halal sector, Islamic mutual funds, infrastructure development, and sukuk bonds. There are growing trends especially in Islamic electronic modes of products and services. These driving factors are bringing investment toward an inclusive growth of the economy. Interestingly, Islamic banking developed extensively in the past few years, which track a good prospect, especially during the recent credit crunch and instability. Islamic banking is growing extensively over the globe. Young’s World Islamic Banking Competitiveness Report 2013 reports that the size of Islamic financial industry had reached from $1.66 trillion to $2.1 trillion in 2015. Further, we can see the actual and expected growth of Islamic financial asset globally from 2007 to 2020 in Figure 11.1. In 2009, 1 trillion USD and 2.5 trillion USD were recorded and was forecasted to hit 3 trillion USD in 2020, according to an IJIMS report. The development and stability of the Islamic financial industry will benefit Muslim countries particularly, and the rest of world generally, in terms of economic development, poverty reduction, business opportunities, trade balances, capital formation, financial inclusion, and circulation of conservative wealth. Nosheen and Rashid (2019) have noted that contribution of Islamic banks to economic growth is well mentioned and profound as compared with conventional banks in same economy because Islamic banks are quite different in nature and the composition of assets and liabilities as compared with their conventional counterparts. 3.5 3 2.5 2 1.5 1 0.5 0 2007

2008

2009

2014

2015

2016

USD Trillions 2010 2017

Figure 11.1 Expected Islamic Assets Globally

170

2011

2012

2013

2018

2019

2020

I SL A M IC BA N K I NG A N D GROW T H

Indeed, shari’ah-compliant economic activities and market structure are the basic need of Muslim communities because Islamic society is strictly prohibited from dealing with interest-based economic transactions, and whoever ignores this instruction is declared to be at war against Allah Almighty and Prophet Muhammad (PBUH) according to the instruction of the Qur’an, 2: 275–278. Ultimately, low savings rate and lack of funds to invest result in a downfall in the aggregate demand of an economy in the conventional context (Shah et al., 2017). Further, the objectives of shari’ah may not be realized because of lack of interest-free avenues to park the excess funds of the Muslim population to meet the growth objective of any government economic policy. Although Furqani and Mulyany (2009), Abduh and Umar (2012), Tabash and Dhankar (2014), Kusuma and Muqorobin (2014), Evans et  al. (2015), Ekimova et  al. (2017), and Olmo et  al. (2018) have explored the association between the financial sector and economic growth in different countries, the relationship between Islamic banking and inclusive economic growth is less explored over the globe, and no study is found to have explored this relationship in the case of Pakistan. This study examines the impact of Islamic banking on economic growth, supporting the argument that Islamic banking leads to inclusive economic growth. This study intends to investigate how Islamic banking contributes to inclusive economic growth. Parallel to this objective, we analyze the impact of Islamic banking on economic growth. This study expects that investors and policy makers will confidently support Islamic banking for sustained growth in Pakistan. It appears as a trendsetter for researchers to consume their efforts in this avenue. In line with the above need, Islamic banking and finance (IBF) are based on the philosophies of shari’ah as an alternate banking in the framework of Islamic law of business contracts to achieve the objectives of the shari’ah. It will encourage students to pursue a career studying the increasing impacts of Islamic banking on the economy, especially with regard to the paradigm of UN-new global development agenda of sustainable development goals (SDGs). Overall, this study is equally important for academicians and practitioners in the domain of Islamic banking. The study is structured as follows. In Section 11.2, the empirical literature is reviewed on the subject matter. We explain data and the empirical framework in Section 11.3. The empirical findings are discussed in Section 11.4. Finally, in Section 11.5, the study is concluded with policy recommendations to endorse the agenda of IBF to achieve economic growth.

11.2 Literature review The inclusive growth approach belongs to a longer-term aspect of the economy. There is a need for projects that provide a series of employment opportunities rather than income redistribution. It is notable that inclusive growth indicates both to the pace and pattern of growth in an economy, which are 171

SYED MUHAMMAD ABDUL REHMAN SHAH ET AL.

interlinked to achieve the objectives of a state (Ravallion, 2001). Therefore, there is a vital need to address both the pace and pattern of growth together. The relationship between financial stability and economic growth has been explored in a series of research papers since the 19th and 20th centuries. Bagehot (1873) and Hicks (1969) have mentioned that the financial system has played a basic role is mobilizing resources to industrialize England. By narrowing down the discussion, Schumpeter (1911) has highlighted the role of the banks in economic growth as one of financial intermediation. They have indicated the same directional effect of financial capital on economic growth and its mechanism underlying the long run relationship between finance and economic growth through the productive investment of funds in the same economy. Overall, a sound financial system can fuel a country’s growth agenda through latest technology in line with empirical literature. The concept of inclusive growth can also be implemented only when we have an economy with sound regulatory framework, innovative products, and formation of human and financial capital. Interdependency of the financial sector and economic growth is observed differently in different economies. Since the financial system is actively responsive on such a development, a higher economic performance could be achieved. Financial development is found to be strongly associated with economic growth both in the short-term and in the long-term (Xu, 2000). He has pondered deeply on such a connection between the development of financial sector and economic growth, and at the end, the causality directional approach is equipped to finally fall into three categories: initially, financial development affects economic growth. Second, economic growth affects the financial sector, and thirdly, bi-directional causality between financial development and economic growth affects each other. The former argues that the financial sector bridges the gaps between excess funds and short funds through the role of financial intermediation. Similarly, Schumpeter (1912), Demetriades and Hussein (1996), Levine (1997), Ahmed and Ansari (1998), Fase and Abma (2003), Bangake and Eggoh (2011), Jedidia et al. (2014), Herwartz and Walle (2014), Durusu-Ciftci et al. (2017), Ekimova et al. (2017), and Olmo et  al. (2018) have argued that this approach is considered as a significant method in promoting economic development. The latter hypothesize that high economic growth requires a sound financial market as a prerequisite to achieve the intended targets. Similarly, Robinson (1952), Li et al. (1998), and Dollar and Kraay (2002) have documented that the financial sector’s improvement affects economic growth in different economies. In the recent past, a series of global economic crises as the Mexican crisis, Indonesian crisis, Sudan crisis, and the current global financial crisis have occurred. All of them describe a potential disequilibrium to the real economy because of the problems that emerged from the financial sector. Therefore, the role of financial activity cannot be excluded in developing the economic growth of a nation. This is because the financial sector functions 172

I SL A M IC BA N K I NG A N D GROW T H

as a financial intermediary that accumulates capital from the household sector or as a savior to the business sector, in which the capital will be used to generate growth in the real sector, which will absorb the available labor in a market. Further, Stolbov (2013) debates that systems of banks and markets appear to be equally imperative. He has found that both sectors of the financial system are found to be positively contributing to economic growth. Islamic banking (Arabic; ‫ )مصرفية إسلمية‬is a financing activity in compliance with shari’ah (Islamic law) and it is practically applied through the Islamic economics framework. Islamic banking industry has achieved its distinction recently due to the unique contractual arrangements and assetbacked financing as a unique set of characteristics. Some of the Islamic banking modes include mudarab’ah, musharak’ah, murabah’ah, salam, istisn’ah, and ijar’ah, which support the development of real sector economy to enhance the growth of an economy. Ayub (2007) has noted that shari’ah prohibits interest (riba, usury, ribit) paid on all money loans. Similarly, investment should be strictly through halal (valid, permissible) goods or services, whereas any investment contrary to Islamic principles (e.g. pork, porn, or alcohol) is also haram (void). In line with the same instructions, El-Gamal (2001) has explored that several traditions of the Holy Prophet Muhammad PBUH are found to be prohibiting games of chance and bai-algharar (uncertainty of legal results). Al Rahahleh et al. (2019) have analyzed that Islamic banks are riskier as compared with their conventional counterparts because of the structure of contract, legal cost, products and governance structure, regulatory and supervisory framework, and liquidity infrastructure. Therefore, we need to be more conscious about the sensitivity of Islamic products to riba and gharar. In accordance with the above-reviewed literature about the relationship between the financial sector and economic growth, Bashir (1999), Wilson (2000), Furqani and Mulyany (2009), Rammal (2010), Mohieldin et al. (2011), Abduh and Omar (2012), and Tabash and Dhankar (2014) have explored the link between Islamic banks’ financing and economic growth. This newly developing financial market of Islamic banks is closely associated with financial intermediaries, particularly those affecting the real economy. Yet, this is a less explored area of a new market, especially in countries with the dual banking system: Islamic and conventional banks. By exploring the nexus of Islamic banks’ financing and economic growth in Indonesia through quarterly data from 2003 to 2012, Abduh and Omar (2012) have utilized the bound testing method of co-integration and error correction models. These are settled within the framework of an auto regressive distributed lag (ARDL) to conduct the causality analysis. They have explored the link among Islamic banks’ financing and economic growth and recommended the government to design all policies in the financial market to support the Islamic financial sector for the sake of economic development. However, using different time span of data, results of Furqani and 173

SYED MUHAMMAD ABDUL REHMAN SHAH ET AL.

Mulyany (2009) and Abd Majid and Kassim (2015) have slightly changed the causality direction, but overall, they confirm an association among Islamic banks’ financing and economic growth. Tabash and Dhankar (2014) found empirical evidence on the relationship in the Middle East between the Islamic finance and economic growth nexus especially for Qatar, Bahrain, and United Arab Emirates (UAE) and indicate that it appears to be a bi-directional correlation for Bahrain and Qatar using the Granger causality test. The results obtained for the United Arab Emirates (UAE) indicate that the causal relationship emerges in one direction, which uses Schumpeter’s supply-leading theory. Similarly, Al Rajhi et al. (2012) explored that many opportunities can be availed through the Islamic financial market to finance development projects. This agenda may bridge these financing gaps in the private as well as the public sectors with the help of global economic organizations. Kusuma and Muqorobin (2014) observe the rapid growth of the Islamic banks in Indonesia and assess the stability of these banks. They prove that the rapid growth of the Islamic banks positively contributes toward the country’s economic growth using the vector auto regression (VAR) analysis. Likewise, Furqani and Mulyany (2009) estimated econometric regression models by using the quarterly data from 1997 to 2005 and concluded that the link between Islamic banks’ financing and economic growth follows the view of “demand-following”, which implies that the growth in the real sector depends on the encouragement of Islamic financing, especially through banks. On the other hand, Abd Majid and Kassim (2015) supported the supply-leading opinion in exploring that the Islamic financial sector is correlated to the basic macroeconomic indicators of Malaysia. Overall, we have found that the relationship between the development of Islamic banking and economic growth has been explored by scholars, such as Furqani and Mulyani (2009) for Malaysia, Abduh and Omar (2012) for Indonesia, Al-Oqool et al. (2014) for Jordan, and Asutay, and Ergec (2013) for Turkey . The empirical literature highlighted how the financial sector in general and Islamic financing in a specific way contribute to economic growth. Further, infrastructural development is a prerequisite to stimulate economic development through the Islamic financial market. It is notable that the development of Islamic banking in regions with Muslim majority, such as Malaysia, Indonesia, Pakistan, Qatar, UAE, Egypt, Kazakhstan, Turkey, Bahrain, Bangladesh, African countries, Russian Islamic states, KSA, and Kuwait, has a substantial potential to practise financial inclusion, thereby promoting inclusive economic growth. In this study, we focus on the subject matter of the nexus between Islamic banking and economic growth in Pakistan where a dual-banking system exists. Yet, the relationship between Islamic banking and inclusive economic growth is less explored over the globe and none of the studies is found to have explored this relationship

174

I SL A M IC BA N K I NG A N D GROW T H

in the case of Pakistan. This study examines the impact of Islamic banking on economic growth that could lead to an inclusive economy. It may help countries with Muslim majority to adopt Islamic banking for capital formation to attain inclusive economic growth.

11.3 Data and methodology 11.3.1 Econometric methodology The Granger causality test is selected to investigate the correlation between Islamic banks’ financing and economic growth. Ordinary least squares (OLS) method is used for regression analysis. As a starting point of analysis, the unit root test was used. Augmented Dickey Fuller (ADF) test for the selected data series was applied before time series regression analysis; ADF is used to test the stationary of the data series in the model. Granger (1969) established causality method as follows: A variable Yt is supposed to Granger-cause to variable Xt when the variable Xt can be forecasted with greater correctness by using previous lag values of the variable Yt rather than not using such previous values, suppose all other terms are held constant. The aim here is to probe the effect of Islamic financing on the economic growth in Pakistan. The Granger causality test for variables initially estimate the following VAR model as: m

Yt = β1 +

∑

m

βiX t +

i =1

∑ γiY

∑

(11.1)

j =1

m

m

Yt = β2 +

t − j + µ1t

ØiX t +

i =1

∑δiY

t − j + µ 2t

(11.2)

j =1

where it is supposed that both μ1t and μ2t are not correlated as error terms. In our analysis, we use the OLS technique to examine the nature and form of relationships among two or more variables included in the model. Yt = α + βX t + u t

(11.3)

Equation (11.3) cannot be observed directly, and we are supposed to collect data sample from the population against variables. Then, the estimates of α and β will help to find the estimated intercept and estimated slope αˆ and βˆ , respectively. ˆ t = αˆ + βˆ X t Y

(11.4)

175

SYED MUHAMMAD ABDUL REHMAN SHAH ET AL.

ˆ t deEquation (11.4) is the sample regression equation. Here αˆ and βˆ and Y note the predicted value of Y. If we have estimated sample regression equation, we can easily predict Y for various values of X. 11.3.2 Model specification The analysis of the study is based upon the standard Cobb–Douglas production function Yt = ALαKβ. This is prominent to investigate the significance of potential variables to economic growth. It is appropriate to explore the relationship between the Islamic banks’ financing and the economic growth as the main goal of the study. ln Yt = α 0 + α1 ln IFt + α2 ln Mt + α3 ln GFCFt + α 4 ln LFt + α5 ln Tt + µ t

(11.5)

In the model, Y represents real gross domestic product (GDP) as a proxy of economic growth. IF denotes Islamic banks’ financing, M symbolizes money supply, GFCF stands for gross fixed capital formation, LF means labor force, and T represents trade openness. Data trends of variables are listed in Appendix 11.1. In detail, a description of variables, their measures, time span, and sources of data collection are summarized in Table 11.1.

11.4 Results and discussion This section explains all estimation results along with discussion and their relevance to the real sector. Before estimating the regression model, descriptive analysis is discussed in detail, unit root test, ordinary least squares, and at the end, Granger causality test results are to be discussed. 11.4.1 Descriptive analysis Descriptive statistics are shown in Table 11.2 for each variable with the necessary description before analyzing the data further. Table 11.1 Description of Variables Variable

Unit of Measurement

Data Source

Real GDP Islamic banks’ financing (IBF) Broad money (BM) Gross fixed capital formation (GFCF) Labor force (LF) Trade openness (TO)

Million rupees Million rupees Million rupees Million rupees

WDI SBP WDI WDI

Million Imports + exports GDP (ratio)

WDI WDI

176

I SL A M IC BA N K I NG A N D GROW T H

Table 11.2 Descriptive  Statistics

Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque–Bera Probability Observations

GDP

BM

GFCF

IBF

LF

TO Ratio

9,225,324 9,052,434 11,229,656 7,638,224 1,025,478 0.315234 2.123454 0.424378 0.786432 11

7,973,526 7,563,246 11,342,256 2,874,241 3,342,213 0.300984 1.933434 0.710270 0.701079 11

1,297,342 1,186,742 1,345,268 1,035,742 107,842 −0.161214 1.828429 0.689324 0.618464 11

465,562.4 376,535.8 1,281,882 81,463.73 340,760.1 1.016331 3.018287 1.893856 0.387872 11

52.78432 54.24324 62.00452 44.64321 4.008764 −0.277438 1.865424 0.746758 0.465321 11

0.298542 0.286732 0.336542 0.234523 0.033421 −0.042342 1.813468 0.6189524 0.723456 11

Table 11.3 ADF Test Results Variable Names

Trend

Trend and Intercept

Stationary

Gross domestic product

−0.4211 (0.7328) −0.4953 (0.8853) −0.71795 (0.8909) −1.4234 (0.3153) −0.3753 (0.8853) −0.3685 (0.8449)

−4.1843 (0.0000) −3.872107 (0.0000) −9.4618 (0.0000) −8.3516 (0.0000) −6.47217 (0.0000) −9.2304 (0.0000)

I(0)

Islamic banks’ financing Money supply Gross fixed capital formation (GFCF) Trade openness Labor force

I(0) I(0) I(0) I(0) I(0)

Source: Values in parentheses are probabilistic values.

In Table 11.2, the mean value of GDP, broad money, GFCF, IBF, labor force, and trade openness is 9,225,324 ratios million rupees on average, 7,973,526, 1,297,342, 465,562.4 in million rupees, 52.78432 million in numbers, and 0.298542 million (in ratio), respectively. Further, dispersion of data set is also checked out by standard deviation. Normality of the data distribution is observed with the help of the values of kurtosis and skewness. Skewness is a measure of asymmetry of probability distribution of a definite value arbitrary variable about its mean. Kurtosis tells us about the degree of peakedness or smoothness of the uni-model frequency curve. Mesokurtic showed the normality of data distribution. Further, the Jarque–Bera test was also used to observe the normality of data distribution. We observe that all values are there within the normal defined standard benchmarks to proceed for further analysis. 177

SYED MUHAMMAD ABDUL REHMAN SHAH ET AL.

Table 11.4 Results of Ordinary Least Square (OLS) Variables

Coefficients

Standard Error

Probability

Remarks

IB financing Broad money GFCF Labor force Trade openness Constant

0.27 0.26 0.23 0.40 0.17 11.55

0.09 0.06 0.19 0.17 0.25 2.56

0.0015 0.0012 0.0911 0.0305 0.5006 0.0043

Significant Significant Significant Significant Insignificant Significant

Source: E-views’ results.

11.4.2 Unit root analysis In general, unit root tests are tests for stationarity in a time series. A time series has stationarity if a shift in time does not cause a change in the shape of the distribution; unit roots are one cause for the non-stationary processes. These tests are known for having low statistical power. Many tests exist, in part, because none stand out as having the most power. The Dickey–Fuller test (sometimes called a Dickey Pantula test) is based on linear regression. During econometric analysis, serial correlation can be an issue, therefore, the ADF test is used. The task of the test is to determine whether the stochastic component contains a unit root or is stationary. In Table 11.3, we observe that all variables achieved the desired level of stationarity at I(0) to move to analysis. 11.4.3 Ordinary least squares method (OLS) From the results of the OLS method, we observe that there is a positive association between Islamic banking financing and economic growth in line with Furqani and Mulyany (2009), Abd Majid and Kassim (2015), Abduh and Omar (2012), Abdul Manap et al. (2012), Kusuma and Muqorob (2014), and Tabash and Dhankar (2014). Islamic financing increases the number of participants (financial inclusion) in financial markets because Pakistan has a majority of Muslim population and they are interest-sensitive. Hence, Islamic investment avenues provided them an opportunity to park their abundant funds. This confidence has increased the overall economic growth of the country as empirical results supported our hypothesis of a positive significant association of Islamic finance with economic growth. Similarly, this result supports the promotion of Islamic banking to achieve economic growth as an objective of the UN agenda for SDGs. Broad money (money supply) is also found to be positively and significantly associated with economic growth. This is because an increment in the general price level enhances the incentive to produce to collect more profit. As a result, this process becomes a cause for increasing the production of goods and services, which increases the economic growth of the country. 178

I SL A M IC BA N K I NG A N D GROW T H

Gross fixed capital formation has significant positive association with the economic growth of Pakistan. Growth is affected 0.23% due to 1% change in GFCF. It means that GFCF plays a vital role in determining economic growth. It is notable that GFCF is used here as a proxy to capital. As per economics literature, investment has a positive impact on GDP growth. Developing countries face severe problems in the formation of capital as people are unemployed or offered employment but on compromised opportunities. Similarly, it also affects savings adversely. As a result, there appears a sharp decline in investment and capital formation of the economy. Labor force positively affects the economy as a potential variable. On empirical grounds, the growth accounting approach to measure the contribution of labor reveals a positive and significant impact on Pakistan’s economy. The current statistics reveals that Pakistan has improved its formation of human capital through skill and education, which enhances labor efficiency in the best manner. The economic survey of Pakistan during 2016–2017 has recorded the contribution of labor force to GDP with 42.3%, 35.1%, and 22.6% from agriculture, services, and industry, respectively. These results reveal the contribution of skilled labor has been changing among sectors of the economy. Trade openness has a positive impact on economic growth, although this variable is found to be statistically insignificant in our analysis. One should note that liberalized economies enjoy foreign direct investment. This channel expands market opportunities, decreases cost per unit of goods, and hence specialization starts in professions based on comparatives advantages. Theoretically, technological transmission becomes a reason to attain the attention of foreign investors; therefore, trade openness is used as a proxy variable that affects GDP growth positively. On practical grounds, however, uncompetitive developing economies face hurdles, as they need protection to grow in the global market. We conclude that Pakistan is not competitive in some aspects ; it needs protection to mature. In this way, it can enhance quality and quantity in the international market to harvest the benefits of an open economy. 11.4.4 Granger causality analysis The results of Engle Granger Causality test are presented in Table 11.5. There are the causal relationships among different variables. Basically, the Engle Granger Causality test is a form of different predictability where the long run relationship between different variables is established in the discussed model. These hypotheses are established according to the probability values of Granger causality relationships in Table 11.5. According to the probability value, we reject the null hypothesis on the causal relationship between Islamic banking and financing (IBF) and GDP. This rejection of null hypothesis supports that IBF does cause GDP. We can 179

SYED MUHAMMAD ABDUL REHMAN SHAH ET AL.

Table 11.5 Granger Causality Results Null Hypothesis:

Obs.

F-Statistic

Prob.

Islamic banks’ financing does not Granger-cause GDP GDP does not Granger-cause Islamic banks’ financing Broad money does not Granger-cause GDP GDP does not Granger-cause broad money GFCF does not Granger-cause GDP GDP does not Granger-cause GFCF Labor force does not Granger-cause GDP GDP does not Granger-cause labor force Trade openness does not cause GDP GDP does not Granger-cause trade openness

11

2.95432

0.0017

3.56342

0.1437

1.03224 2.43242 3.32452 2.72342 2.06342 5.56742 1.56323 3.56421

0.0068 0.0075 0.0124 0.1254 0.0046 0.0324 0.2642 0.1252

11 11 11 11

Source: E-views’ results.

say that we have been successful in supporting our core theme of study that IBF contributes to a country’s economic growth. This result also supports us in achieving SDGs of the UN. Similarly, broad money (M), GFCF, and labor force (LF) Granger-cause GDP In contrast to trade openness (T), which does not Granger cause GDP as reflected by the probability values. Overall, we found the abovementioned variables have effectively affected GDP.

11.5 Conclusion and recommendations Economic development has been a prime objective of any growing economy. Policy makers have been interested in finding out potential variables to achieve the said objective of economic growth. The same agenda is a fundamental part of the SDGs targeted by the UN for 2030. We have examined that the development of Islamic financial institutions in Pakistan will lead to economic growth and development. In countries with Muslim majority like Pakistan, Islamic financing has emerged as the best source of financial inclusion to achieve the objectives of economic growth. The same religious taste can be a potential source of economic growth in countries with dual banking, for instance, Malaysia, Sudan, Indonesia, UAE, Turkey, and Egypt. On the basis of empirical results, we recommend policy makers to increase the share of IBF to provide halal investment opportunities for the Muslim population. Many Muslim countries have been considered developing economies for whom these empirical results may appear to be a sign of hope, which shows a positive relationship between Islamic banks’ financing and economic growth. It will also play a vital role in the long run for capital formation, financial inclusion, economic welfare, and poverty alleviation

180

I SL A M IC BA N K I NG A N D GROW T H

in line with SDGs of the UN. We recommend Muslim countries and countries with Muslim majority to tap into the Islamic financial market potential through the development of the regulatory framework, shari’ah auditing, and Islamic branch expansion. Yet, IBF is a less explored area in the local and global markets. Last but not least, central banks of Islamic countries should observe the potential of IBF, Islamic micro-financing schemes, waqf, Islamic mutual funds, and Islamic non-banking financial companies to contribute to the growth of the economy. These arrangements are the best source for financial inclusion and capital formation. As future research agenda, researchers are expected to present sound models on the fiscal aspect of Islamic economics by exploring how Islamic fiscal tools can contribute to the growth of Muslim majority economies. Appendix 11.1 Industry progress and market share Particulars

Industry Progressa

YoY Share in Overall Growth Banking Industry (%)a (%)

Dec-18 Sep-19 Dec-19 Dec-19 Dec-18 Sep-19 Dec-19 Assets (rupees in billion) Deposits (rupees in billion) Number of Islamic banking institutions Number of Islamic banking branchesb

2,658

2,995

3,284

23.5

13.5

13.8

14.9

2,203

2,407

2,652

20.4

15.5

16.1

16.6

22

22

22

–

–

–

–

2,851

29,79

3,226

13.2

–

–

–

Source: SBP Islamic Banking Bulletin, December 2019. Source: Data submitted by banks under quarterly Reporting Chart of Accounts (RCOA). a Figures in this bulletin are rounded off. b Including sub-branches.

References Abd Majid, M. S., & Kassim, S. (2015). Assessing the contribution of Islamic finance to economic growth: Empirical evidence from Malaysia. Journal of Islamic Accounting and Business Research, 6(2), 292–310. Abduh, M., & Azmi Omar, M. (2012). Islamic banking and economic growth: The Indonesian experience. International Journal of Islamic and Middle Eastern Finance and Management, 5(1), 35–47. Abdul Manap, T. A., Abduh, M., & Omar, M. A. (2012). Islamic banking growth nexus: Evidence from Toda-Yamamoto and Bootstrap Granger causality test. Journal of Islamic Finance, 176(813), 1–8.

181

SYED MUHAMMAD ABDUL REHMAN SHAH ET AL.

Ahmed, S. M., & Ansari, M. I. (1998). Financial sector development and economic growth: The South-Asian experience. Journal of Asian Economics, 9(3), 503–517. Al Rahahleh, N., Bhatti, M. I., & Misman, F. (2019). Developments in risk management in Islamic finance: A review. Journal of Risk and Financial Management, 12(1), 37. Al Rajhi, A., Al Salamah, A., Malik, M., & Wilson, R. (2012). Economic Development in Saudi Arabia. London: Routledge Taylor and Francis Group. Al-Oqool, M. A., Okab, R., & Bashayreh, M. (2014). Financial Islamic banking development and economic growth: A case study of Jordan. International Journal of Economics and Finance, 6(3), 72–79. Asutay, M., & Ergeç, E. H. (2013). Financial development and economic performance nexus in the case of Islamic and conventional Banks in Turkey: An empirical analysis, 9th International Conference on Islamic Economics and Finance, Istanbul. Ayub, M, (2007). Understanding Islamic Finance. London: John Wiley & Sons Ltd. Bagehot, W. (1873). Lombard Street: A Description of the Money Market. London: HS King. Bangake, C., & Eggoh, J. C. (2011). Further evidence on finance-growth causality: A panel data analysis. Economic Systems, 35(2), 176–188. Bashir, A.-H. M. (1999). Monetary policy and economic growth: An Islamic perspective. Proceedings of the Third Harvard University Forum on Islamic Finance. Centre for Middle Eastern Studies, Harvard University, 13–22. Demetriades, P. O., & Hussein, K. A. (1996). Does financial development cause economic growth? Time-series evidence from 16 countries. Journal of Development Economics, 51(2), 387–411. Dollar, D., & Kraay, A. (2002). Growth is good for the poor. Journal of Economic Growth, 7(3), 195–225. Durusu-Ciftci, D., Ispir, M. S., & Yetkiner, H. (2017). Financial development and economic growth: Some theory and more evidence. Journal of Policy Modeling, 39(2), 290–306. Ekimova, K., Kolmakov, V., & Polyakova, A. (2017). The credit channel of monetary policy transmission: Issues of quantitative measurement. Economic Annals-XXI, 166(7–8), 51–55. El-Gamal, M. (2001). An economic explication of the prohibition of gharar in classical Islamic jurisprudence. Islamic Economic Studies, 8(2), 29–58. Evans, C., Fisher, J., Gourio, F., & Krane, S. (2016). Risk management for monetary policy near the zero-lower bound. Brookings Papers on Economic Activity, 2015(1), 141–219. Fase, M. M., & Abma, R. C. N. (2003). Financial environment and economic growth in selected Asian countries. Journal of Asian Economics, 14(1), 11–21. Fuinhas, J. A., Marques, A. C., & Faria, S. D. S. (2017). Natural resources, globalization and sustainable economic welfare: A panel ARDL approach. Estudios de Economía Aplicada, 35(3), 653–671. Furqani, H., & Mulyany, R. (2009). Islamic banking and economic growth: Empirical evidence from Malaysia. Journal of Economic Cooperation & Development, 30(2), 59–74. Granger, C. W. (1969). Investigating causal relations by econometric models and cross-spectral methods. Econometrica: Journal of the Econometric Society, 424–438.

182

I SL A M IC BA N K I NG A N D GROW T H

Herwartz, H., & Walle, Y. M. (2014). Determinants of the link between financial and economic development: Evidence from a functional coefficient model. Economic Modelling, 37, 417–427. Hicks, J. (1969). A Theory of Economic History (Vol. 9). Oxford: Oxford University Press. Jedidia, K. B., Boujelbène, T., & Helali, K. (2014). Financial development and economic growth: New evidence from Tunisia. Journal of Policy Modeling, 36(5), 883–898. King, R. G., & Levine, R. (1993). Finance and growth: Schumpeter might be right. The Quarterly Journal of Economics, 108(3), 717–737. Kusuma, D. B. W., & Muqorobin, M. (2014). Assessing financial stability on Islamic banks and its contribution to economic growth: Empirical evidence from Indonesia. ISRA International Colloquium for Islamic Finance (IICIF, 2014), Lorong University, Kuala Lumpur, 1–32. Levine, R. (1997). Financial development and economic growth: Views and agenda. Journal of Economic Literature, 35, 688–726. Li, H., Squire, L., & Zou, H. F. (1998). Explaining international and intertemporal variations in income inequality. The Economic Journal, 108(446), 26–43. Mansor, F., Al Rahahleh, N., & Bhatti, M. I. (2019). New evidence on fund performance in extreme events. International Journal of Managerial Finance, 15(4), 511–532. Mohieldin, M., Iqbal, Z., Rostom, A., & Fu, X. (2011). The Role of Islamic Finance in Enhancing Financial Inclusion in Organization of Islamic Cooperation (OIC) Countries. Washington, DC: The World Bank. Nosheen, & Rashid, A. (2019). Business orientation, efficiency, and credit quality across business cycle: Islamic versus conventional banking. Are there any lessons for Europe and Baltic States? Baltic Journal of Economics, 19(1), 105–135. Olmo, B. T., Azofra, S. S., & Sáiz, M. C. (2018). Creditor Rights and the Bank Lending Channel of Monetary Policy, CSR, Sustainability, Ethics & Governance, in: Belén Díaz Díaz & Samuel O. Idowu & Philip Molyneux (ed.), Corporate Governance in Banking and Investor Protection, chapter 0, pp. 107–122. Springer London. Rammal, H. G. (2010). Islamic finance: Challenges and opportunities. Journal of Financial Services Marketing, 15(3), 189–190. Ravallion, M. (2001). Growth, inequality and poverty: Looking beyond averages. World Development, 29(11), 1803–1815. Robinson, J. (1979). The generalisation of the general theory. In The Generalisation of the General Theory and Other Essays (pp. 1–76). London: Palgrave Macmillan. Schumpeter, J. A. (1911). The Theory of Economic Development. Cambridge, MA: Harvard University Press. Shah, M. A., Rashid, A., & Khaleequzzaman, M. (2017). Capital structure decisions in Islamic banking: Empirical evidence from Pakistan. Journal of Islamic Banking & Finance, 34(2). 88–103. Stolbov, M. (2013). The finance-growth nexus revisited: From origins to a modern theoretical landscape. Economics: The Open-Access, Open-Assessment E-Journal, 7(2), 1–22.

183

SYED MUHAMMAD ABDUL REHMAN SHAH ET AL.

Tabash, M. I., & Dhankar, R. S. (2014). The flow of Islamic finance and economic growth: An empirical evidence of Middle East. Journal of Finance and Accounting, 2(1), 11–19. Wilson, R. (2000). Challenges and opportunities for Islamic banking and finance in the west: The United Kingdom experience. Islamic Economic Studies, 7(1&2), 35–59. Xu, Z. (2000). Financial development, investment, and economic growth. Economic Inquiry, 38(2), 331–344.

184

12 THE ROLE OF ZAKAT IN ADDRESSING POVERTY An analysis of Sokoto state Zakat and Waqf (Endowment) Commission Aminu Alhaji Bala 12.1 Introduction Zakat in Arabic literally means purity, increase in blessings and commendation.1 In technical usage, it is giving out specified obligatory dues from specified quantity of wealth, over a specified period to specific people under specific conditions.2 It is the third pillar of Islam and one of its great basis. In the Hadith reported by Ibn Umar, Zakat is the third principle of Islam after testimony of the Shahadah and observance of Prayers.3 It is obligatory according to the Qur’an, Sunnah, and Ijma’ of the Muslim Ummah upon any free Muslim who possesses wealth that reaches nisab and the year has passed upon it to pay the Zakat.4 It is also paid from one’s possession (inventory stock) for the purpose of sale, if its value reaches nisab, these commodities include land and buildings and all other commodities that one trades with.5 During the period of the Prophet (SAW), zakat was collected on the commodities owned for trading purposes.6 Zakat is also collected from the guardians from the wealth of the insane and orphans on their behalf upon satisfying all the conditions for its payment due to the generality of the evidences.7 As for grains and fruits, zakat will paid upon their ripeness8 as contained in the Qur’an Chapter 6, Verse 141. Zakat was ordered at Makkah, but its specified amount was established (and made compulsory) at Madinah in the second year after Hijrah. Allah (SWT) imposed zakat in the Qur’an and mentioned it together with Salah in one verse in 26 places; in one place it was mentioned together with Salah within four verses dealing with one subject matter (Q23 Vs 1–4) and it was mentioned alone in three places (Q7 V 156, 30 V 39 and 41 V 6–7) making a total of 30 places in the Qur’an where Allah (SWT) mentioned zakat. Again, it was mentioned in the Qur’an with the word Sadaqah or Sadaqaat in 12 places – all these indicating its importance. In the Sunnah there are also numerous ahadith dealing with zakat. Imam Ibn al-Athir mentions about 110 of them dealing with different aspects of zakat and these ahadith were DOI: 10.4324/9781003050209-12185

A minu A lhaji B ala

more than that number in the books of Sunan – all these indicating the importance of zakat in Islam. Muslim scholars have unanimously agreed that zakat is an obligatory act, whoever denies it is a disbeliever and those who refrain from giving it are to be fought.9

12.2 Benefits of Zakat Zakat is a social security in Islam so that wealth does not concentrate within the wealthy class alone. It is the cause of increasing one’s wealth and brings Muslims together as one family and increases blessings to one’s wealth. Allah (SWT) also replaces it with abundant reward and blessings. It similarly prevents criminal acts of stealing and armed robbery in society and it lessens the burden of poverty among the poor and indigent. Above all, it is the cause of entering Paradise and prevents the wrath of Allah in both worlds.10

12.3 A severe warning for those refusing to offer zakat Allah (SWT) has issued a stern warning in the Qur’an to those who refused to offer zakat. Their wealth is going to be a means of punishment in the Hereafter and they will test the torment in Hell fire.11 Many verses have warned those who covetously withhold their wealth from zakat of severe punishment.12

12.4 The recipients of zakat Allah (SWT) has stated whom should be given zakat. Any person who is not a recipient should not be given zakat; one must handover zakat to only those who have a right to it. A person is also required to give it to those in charge of collecting the proceeds of zakat, who in turn hand it to the eight categories of recipients13 mentioned in Chapter 9 Verse 60 of the Qur’an. Zakat as highlighted above is best handled by the government or its agencies like the zakat and Waqf committees established by the many state governments in Northern Nigeria.14 This is the best and most useful way to collect and distribute it to those who deserve it only. The Prophet (SAW) used to appoint some of the companions to administer the collection of zakat as we have seen in the Hadith of Muaz (RA) and Muslims have the best example from him. This will help to meet the needs of the deprived classes and leads to a state of balance between the haves and have-nots.

12.5 Review of literature Although no research has been done on the assessment of the levels of poverty alleviation among the people of Sokoto state using the Sokoto State Zakat and Endowment Commission as a case study, some similar works exist, which this research has benefitted from. These works include that of 186

ROL E OF Z A K AT

Mahmud,15 which investigated the Bangladesh experience. They adopted the logit model where the dependent variable was household total expenditure (measured as a proxy for poverty) while the independent variables were the households’ total income and their total savings. The findings reveal that the zakat proceeds did not alleviate rural poverty. Some studies are done on the effectiveness of zakat in the redistribution of wealth in Kebbi state of Nigeria. In these studies performance criteria wad adopted to outreach sustainability where the dependent variable is zakat as a proxy of poverty alleviation, while the independent variables used were administrative efficiency, staff productivity, level of education, sex, age, and marital status. Their findings reveal that zakat is an effective fiscal policy tool of wealth redistribution, especially if it is collected at the right time and disbursed to the right recipients. For example the work of Isa;16 who observed that some northern states officially established organs of zakat administration. It was reported that these states had significant achievement over the years in the collection and distribution of zakat. This research is relevant in that it gives a historical background on the administration of zakat in Islam. However, only a paragraph has been dedicated to the discussion on the establishment and administration of zakat in Sokoto state; this work, therefore, intends to bridge the gap left by assessing the level of poverty reduction in Sokoto state through the activities of the zakat and Endowment Committee, which was not discussed in Isa’s work. The work of Maidoki and Sani17 is another example which reviewed, and it focused on some operational and management issues of the Sokoto State Zakat and Endowment Committee and finally presented some achievements and challenges of the committee. However, like the other studies that were reviewed, this work did not assess the role played by the commission in poverty alleviation in Sokoto state through the activities of the zakat and Endowment Commission, which has been addressed by the present research.

12.6 Theoretical framework This research adopted functionalist organizational theory as a theoretical framework. Functionalism views society more than its parts and each aspect of it works for the stability of the whole. Thus the various parts of a society are interrelated and, therefore, easily allow the understanding of the parts of a society in relation to society as a whole.18 In line with the assumptions of the functionalist perspective, this study examines the contribution that the Sokoto State Zakat and Endowment Commission makes to meet the needs of the poor; the findings of this study show that the activities of the Commission exist to serve a vital social function toward poverty alleviation. This plays a considerable role in enhancing social cohesion and integration of individuals into society through the alleviation of their hardship and by giving them a sense of belonging. 187

A minu A lhaji B ala

12.7 Research methodology This research adopts the analytical method by collecting qualitative data and providing an analysis based on several findings from the literature on zakat and other primary sources. The chapter focuses specifically on the articles written on zakat and pamphlets and government publications dealing with case studies. Techniques for data collection and analysis are very important for any given research in helping to understand how information is gathered and processed. The technique used here is the analytical method on the literature gathered about zakat. The research captured data and variables on the sampled zakat collection and distribution within the 86 districts of Sokoto state. The data sought was analyzed in this research, which determined the role of zakat in addressing poverty by the Sokoto State Zakat and Waqf Commission.

12.8 Results and discussion Sokoto State Zakat and Waqf (Endowment) Commission was initially known as the Sadaqat committee that operates from 1988 to 2007; between 2007 and 2016, the Sadaqat committee changed its name to Sokoto State Zakat and Endowment Committee, and from 2016 to date, it has been known and addressed as Sokoto State Zakat and Waqf (Endowment) Commission. Sokoto is a state with over four (4) million population located within the north-west region of Nigeria. Over 99.9% of the population are Muslims of different tribes, backgrounds, occupations, and economic statuses.19 The commission is empowered by law No. 11 of 2016 of the Sokoto State house of assembly. The state-backed law rendered regulating the administration of zakat and management of waqf to the commission throughout the state.20 The commission relies on traditional institutions for local coordination and mobilization. In fact, the board liaised with over 86 district heads who collect and distribute zakat.21 Zakat collected at each district is distributed within the same locality to the beneficiaries mentioned in the Qur’an.22 The law that helped establish the commission also provides for enforcement clauses against defaulters, and failure to pay zakat is to face some judicial consequences.23

12.9 Health assistance to the sick and needy The sick person who is not able to earn an income and does not have money that he or she can spend on medical treatment is the one who is entitled to health assistance offered by the commission. Paying all or assisting in medical bills that are proven to be difficult by the sick person as well as paying for hospital surgery and tests, drugs, and other medical expenses were carried out monthly through the funds of zakat and waqf. The commission offered free medical assistance for poor families and small-scale business enterprise 188

ROL E OF Z A K AT

owners who cannot meet their medical bills. The patients who benefitted through the drugs brought medical prescriptions and are poor people who cannot purchase medicines.24 In addition to the above, funds were also allocated for the treatment of mentally ill persons at a psychiatric hospital.25 12.9.1 Ramadan packages for the orphans and needy Muslims throughout the month of Ramadan are more charitable and courageous in assisting the poor, the needy, and the less privileged. This is so because the month of Ramadan is a month of mercy and great reward. Sokoto State Zakat and Waqf (Endowment) Commission also offered Ramadan assistance for the orphans and needy with food items, clothing materials, and some amount of money to enable them to participate in Ramadan fast and Eid festivity with ease. In 2016 the commission distributed 3,000 bags of rice, 9,000 bundles of clothing materials, 485 units of grinding machines, and 485 sewing machines. This is to strengthen the conscience of the poor and empower them financially and materially so that they can stand on their own during the month of Ramadan and Eid festivity.26 12.9.2 Assistance for the orphans and needy Considering many verses and hadith of the Prophet (SAW) on the importance of assisting the orphans and needy people, the Commission formed a committee that identifies orphans and those desperately in need who include the elderly and widows who have no family members, guardians or neighbors, mostly in the rural and urban areas of the state to assist them. Over the years, the committee assisted such people with food items and other special needs, renovation of their accommodation, settlement of rent and provision of small-scale capital for running a business. Special consideration is also given to these people during zakat distribution.27 12.9.3 Monthly allowances for people with disabilities As a rewarding gesture, the commission rendered monthly assistance to people with disabilities ranging from lepers, those with visual and physical challenges or deformities to discourage them from begging on the streets and from going door to door to people’s houses, the Commission through its committee identified 6,866 people with disabilities throughout the state and gave each one of them a sum of 6,500 naira (N6,500.00) monthly. These people were placed on a monthly allowance for more than seven years.28 12.9.4 Provisions and renovation of accommodations Another welfare package of the commission aimed at addressing poverty is assisting the poor and needy by providing conducive accommodation such 189

Aminu Alhaji Bala

as a basic shelter for the victims of fire and flood and those whose accommodation had been ruined by rain or any other natural calamity. In 2016, a total of 549 people benefitted from one kind of assistance or the other. In this category, 102 people received complete house repairs, 20 received room renovation packages, and 18 people were provided with rent settlement to relocate.29 12.9.5  Yearly zakat collection and distribution at the district level Committees were shouldered with the responsibility to distribute zakat to the eligible recipients. The Commission was judiciously distributing zakat fund.30 From 2013 to 2015, about 7,517 people benefitted from zakat fund across the 85 districts of Sokoto state.31

12.10  Concluding remarks Zakat is an important pillar of Islam as a social security tool meant for poverty alleviation in Muslim societies. It is a very important and necessary act of Ibadah practiced in any society that wants to please Almighty Allah by obeying His law. To benefit the poor by meeting the needs of less-privileged members of the society, zakat was established in Sokoto Caliphate in 1808 with a well-structured system of collection and distribution throughout the Caliphate. With the arrival of British colonialists, the system of zakat was abolished and replaced with various types of taxations. Sokoto state zakat and waqf (endowment) commission is one of the zakat organizations founded much later after independence from British occupation. Saddled with the responsibility of zakat collection and distribution, the commission no doubt played a vital role in the discharge of their responsibilities, which has tremendously helped in reducing poverty in Sokoto state. From 1996 to date, zakat collection and distribution in Sokoto state has recorded many achievements in the areas of addressing poverty. However, still there is a lot to be done considering the state is one of the poorest in Nigeria. Also, many wealthy Muslims in the state should be enlightened and encouraged to discharge their obligations by paying their dues when due.

Notes 1 Said bn Aliy al-Qahtani, (1431 A.H.), al-Zakat fil-Islam Sunnah, Al-Qasf, Markaz al-Da’wah wal Irshad, P. 5. 2 Said bn Aliy al-Qahtani, (1431 A.H.), al-Zakat fil-Islam Sunnah…, P. 8. 3 See M. M. Khan(1997), The Translation of the Meanings Lebanon, Dar Al-Arabia, Vol. 2. Hadih No. 7. 4 Said bn Aliy al-Qahtani, (1431 A.H.), al-Zakat fil-Islam Sunnah…, P. 8.

190

fi Dau’ al-kitab wasfi Dau’ al-kitab wasof Sahih Al-Bukhari, fi Dau’ al-kitab was-

ROL E OF Z A K AT

5 Baaz, Sheikh Abdul‐Azeez bn, (2004), Zakaah, Rabwah, The Islamic Propagation Office, P. 14. 6 See Imam Abu Dawud and Sulaiman ibn Al-Ash’ath, (2008), Sunan Abu-Dawud, Beirut, Dar al-Kutub Al-Ilmiyah, 2008, Hadith No. 1557. 7 Opcit., P. 15. 8 Ibid., P. 10. 9 Said bn Aliy Qahtani, (1431 A.H.), al-Zakat fil-Islam fi Dau’ al-kitab wasSunnah…, PP. 29–41. See also Baaz, Sheikh Abdul‐Azeez bn, (2004), Zakaah…, P. 5. 10 Ibid., P. 8. 11 Baaz, Sheikh Abdul‐Azeez bn, (2004), Zakaah…, P. 6. See also, Abd al-Razzak Nofal, (1993), al-Zakat: The Poor Due, Cairo, Supreme Council for Islamic Affairs, P. 8. 12 See Qur’an 3;110, 3;180 and 9;34–35. 13 See Said bn Aliy al-Qahtani, (1431 A.H.), Masarif al-Zakat fil-Islam: Mafhum wa shurut wa anwa’u wa ahkam fi Dau’ al-kitab was-Sunnah, Riyadh, MatbaatiSafir. And also Baaz, Sheikh Abdul‐Azeez bn, (2004), Zakaah…, P. 16. 14 Abd al-Razzak Nofal, (1993), al-Zakat: The Poor Due, Cairo, Supreme Council for Islamic Affairs, P. 21. 15 Mahmud et  al., (2015), Impact of Zakat in Alleviating Rural Poverty: A Case Study of MACCA in Bangladesh. A Paper Presented at the 8th International Conference on Islamic and Finance, Doha, Qatar. 16 M. Isa, (2010), The Role of Government Agencies in the Administration of Zakah in Some Selected States of Northern Nigeria. (Unpublished Phd Thesis of Department of Islamic Studies, Usman Danfodiyo University, Sokoto). 17 Maidoki and Sani, (2015), Management of Zakat and endowment to Empower the Needies in Nigeria: Reflections on the Activities of Sokoto State of Nigeria Zakat and Endowment Committee from 2012 to 2015. A Paper Presented to 1st International Journal of Islamic Monetary Economic and Finance, Bank Indonesia, Surabaya, East Java, Indonesia. 18 M. Haralambos and M. Holbourn, (2004), Sociology Themes and Perspective, London, HarperCollins, 2004. 19 Zakat and Endowment in Sokoto State, A publication of Sokoto State Zakat and Waqf (Endowment) Commission, 5th edition, August, 2017, P. 3. 20 Monumental Achievements: Annual Report on the Activities and Events of Sokoto State Zakat and Waqf (Endowment) Commission, 2016, PP. 10–11. 21 The operational modalities are based on Maliki law as contained in fiqh Maliki books common in the area. 22 The Sadaqaat (here it means Zakah) are only for the Fuqara’ (poor), and the Masakiyn (the poor) and those employed to collect (the funds); and for to attract the hearts of those who have been inclined (toward Islam); and to free the captives; and for those in debt; and for Allah’s Cause, and for the wayfarer (a traveller who is cut off from everything); a duty imposed by Allah. And Allah is All‐Knower, All‐Wise (Q 9 V 60). 23 Suleiman, Tajudeen, Zakat to the Rescue: How Sokoto State Is Solving Problems by Taxing the Rich to Pay the Poor, ICIR report, July 18, 2018. https:// www.icirnigeria.org/zakat… visited on 21/10/2018. 24 Ibid. 25 Ibid. 26 Monumental Achievements: Annual Report on the Activities and Events of Sokoto State Zakat and Waqf (Endowment) Commission, 2016, P. 16. 27 Prompt Interventions: Annual Report on the Activities and Events of Sokoto State Zakat and Endowment Commission, Sokoto, Ministry for Religious Affairs, 2015, PP. 11–12.

191

AMINU ALHAJI BALA

28 Prompt Interventions: Annual Report on the Activities and Events of Sokoto State Zakat and Endowment Commission, Sokoto, Ministry for Religious Affairs, 2015, PP. 11–12. See also: Suleiman, Tajudeen, Zakat to the Rescue…, 2018. 29 Monumental Achievements: Annual Report on the Activities and Events of Sokoto State Zakat and Waqf (Endowment) Commission, 2016, PP. 10–11. 30 Suleiman, Tajudeen, Zakat to the Rescue…, 2018. 31 Report on Study Tour, Sokoto State Zakat and Waqf (Endowment) Commission, Sokoto State, Ministry for Religious Affairs, 2016, PP. 29–30.

References Baaz, Sheikh Abdul‐Azeez bn, (2004), Zakaah, Rabwah, The Islamic Propagation Office. Dawud, Imam Abu and Al-Ash’ath, Sulaiman ibn, (2008) Sunan Abu-Dawud, Beirut, Dar al-Kutub Al-Ilmiyah. Haralambos, M. and Holbourn, M., (2004) Sociology Themes and Perspective. London, HarperCollins. Isa, M., (2010) The Role of Government Agencies in the Administration of Zakat in Some Selected States of Northern Nigeria. (Unpublished Phd Thesis of Department of Islamic Studies, Usman Danfodiyo University, Sokoto). Khan, M. M. (1985), The Translation of the Meanings of Sahih Al-Bukhari, Lebanon, Dar Al-Arabia. Mahmud, K. T., Hassan, M. K., SOHAG, M., & Alam, F. (2015). Impact of zakat in alleviating rural poverty: A case study of Masjid Council for Community Advancement (MACCA) in Bangladesh. Access to Finance and Human Development—Essays on Zakat, Awqaf and Microfinance, 23. Maidoki, M. L. and Sani, U. B., (2015) Management of Zakat and Endowment to Empower the Neediest in Nigeria: Reflections on the Activities of Sokoto State of Nigeria Zakat and Endowment Committee from 2012 to 2015. A Paper Presented to 1st International Journal of Islamic Monetary Economic and Finance, Bank Indonesia, Surabaya, East Java, Indonesia. Monumental Achievements: Annual Report on the Activities and Events of Sokoto State Zakat and Waqf (Endowment) Commission, 2016. Nofal, A. E. (1984). Al-Zakat (the poor due) (translated from Arabic by T. Tawfik). Cairo, Egypt: The Supreme Council for Islamic Affairs. Prompt Interventions: Annual Report on the Activities and Events of Sokoto State Zakat and Endowment Commission, Sokoto, Ministry for Religious affairs, 2015. Report on Study Tour, Sokoto State Zakat and Waqf (Endowment) Commission, Ministry for Religious Affairs, Sokoto State, 2016. Said bn Aliy Al-Qahtani, (1431 A.H.) al-Zakat fil-Islam fi Dau’ al-kitab was-Sunnah, Al-Qasf, Markaz al-Da’wah wal Irshad. Suleiman, T. (2018). Zakat to the Rescue: How Sokoto State Is Solving Problems by Taxing the Rich to Pay the Poor, ICIR Report, July 18, 2018. https://www. icirnigeria.org/zakat. Zakat and Endowment in Sokoto State: A Publication of Sokoto State Zakat and Waqf (Endowment) Commission, 5th edition, August, 2017.

192

13 ANALYSES OF SOURCES AND USES OF CHARITY FUND ACCOUNT A case study of “Meezan” bank Mohammad Ayaz, Khurram Faisal Jamal, and Sadaf Shaheen 13.1 Introduction Due to the limited availability of shari’ah-compliant investment avenues, Islamic banks can be compelled to generate income from any unlawful sources unintentionally, like hidden interest-based lending with international banks or, a wrongful penalty amount charged on the customer, in case of delayed payment. Scholars such as Taqi Usmani, Sheikh Muhammad Sadiq al Dharir, and Dr. Nazih Hammad have different views about the treatment of such amounts; however, the dominant view that is also in practice in Pakistan is that it should not be treated as the bank’s profit, but it shall go to charity ( see Ayub, 2007). The State Bank of Pakistan (SBP) has provided instructions regarding charity fund treatment and required Islamic banks to create a charity fund account (CFA). This CFA holds potential non-shari’ah-compliant sources of income or penalties received in lieu of late payments (SBP, 2008). The SBP further requires these Islamic banks to disclose the sources and uses of these charity account funds. With the emergence of Islamic finance, scholars and economists such as Mufti Taqi Usmani, Umar Chapra, Essam Ishaq, and Asad Zaman, have been writing on Islamic finance products, services, Islamic banks’ profitability, and efficiency. But, there is a dearth of literature on the analysis and disclosure of information on the CFA’s sources and use. Charities in Islam need professionalism and greater transparency to protect the sector from accusations of wasting resources or mixing it with lawful income. In this way, the stakeholders of Islamic banks will be confident about the good reputation of Islamic banks. Disclosure of all relevant and material information by banking companies is one of the key elements of good corporate governance. It ensures that management works for the benefit of shareholders and all other stakeholders. For achieving transparency, proper and generally acceptable DOI: 10.4324/9781003050209-13193

M O H A M M A D AYA Z E T A L .

accounting methods as well as standardized disclosure of all relevant information are required (Al Rahahleh et  al., 2019). It refers to the degree to which information flows and is reported freely within an organization, among managers and employees, and outward to stakeholders (Muslim scholars recognize transparency (shafafiyyah) under important values of Islamic corporate governance (See, Al Rahahleh et al., 2019). In Islamic literature, shafafiyyah is reflected in the concepts of transparency in the actions of authority-­holders, disclosure of defect (‘ayb) in merchandise, and the prohibition of gharar (uncertainty) in transactions and documenting of transactions (Ayub, 2007). The current study creates awareness among prospective donees on the disbursement of charity amounts by Islamic banks. It also highlights the level of disclosure and the related policy of “M” Bank that can be beneficial for other Islamic banks while disclosing the sources and uses of their charity accounts’ funds. In light of this study, the regulator will be able to formulate comprehensive guidelines on the disclosure of information related to the CFAs of all Islamic banks. Therefore, the objectives of the chapter are: To explore and analyze the sources and uses of CFAs of “M” Bank; to investigate the level of disclosure of such sources and uses; to achieve these objectives, the structure of this case study is that in the next section, research methodology is discussed, followed by Section 13.3 that includes a discussion on charity in light of the Qur’anic verses and the traditions of the holy Prophet Muhammad (PBUH). Section 13.4 consists of different scholars’ views and the recent literature review on charging penalty in the case of late payment. After that, the SBP’s regulation of the CFAs is discussed in Section 13.5, which is followed by “M” Bank’s Shari’ah Screening Criteria in Section 13.6. The sources and use of “M” Bank’s CFA are explored and analyzed in Section 13.7. Section 13.8 makes an analysis of the CFA. Conclusions and recommendations are presented in Section 13.9.

13.2  Research methodology This study was qualitative in nature, which actually was a case study research on “M” Bank. Qualitative case study research is a story about an individual, organization, or an event (Yin, 2003). Case study research collects as much information as researchers can to understand the phenomenon. In the current study, information is collected from the annual financial statements of “M” Bank, which are accessed through its website. A case study’s research designs help researchers in finding answers to their what, why, and how questions on the study. It helps researchers understand and explore complex phenomena (Harrison et al., 2017). The purpose of the current study has been to explore and analyze as well as to check the level of disclosure of the sources and uses of the CFA of “M” Bank. 194

S OU RC E S A N D USE S OF C H A R I T Y F U N D AC C OU N T

Thus, a case study research was appropriate and advantageous for it because the case study research design proved useful in collecting more detailed information (Neale et al., 2006).

13.3 Charity in Quran and Sunnah Charity is an important pillar of the Islamic ethical economic system. Muslims are encouraged to spend money on others who are needy. This is a moral obligation and emphasized in the Quran and Hadith. For charity, the word sadaqah is used in the Arabic literature, which is used both in the Quran and the Sunnah of the Prophet (PBUH) as Allah says in the Quran: And whoever among you is ill or has an ailment of the head [making shaving necessary must offer] a ransom of fasting [three days] or charity or sacrifice. Al-Baqarah 2:196 Similarly, Allah says: So when they entered upon Joseph, they said, “O ‘Azeez, adversity has touched us and our family, and we have come with goods poor in quality, but give us full measure and be charitable to us. Indeed, Allah rewards the charitable. Yūsūf 12:88 Regarding the importance of charity in Ahadith of the Holy Prophet (PBUH), ‘Aisha said that a person came to the Messenger of Allah and said: My mother died suddenly without having made any will. I think she would have definitely given Sadaqa if she had been able to speak. Would she have a reward if I gave Sadaqa on her behalf? He (the Holy Prophet) said: Yes. Sahih Muslim (1004a) Similarly, Jābir (Allah be pleased with him) reported Allah’s Messenger as saying: Never does a Muslim plants a tree except that he has the reward of charity for him, for what is eaten out of that is charity; what is stolen out of that, what the beasts eat out of that, what the birds eat out of that is charity for him. In short, none incurs a loss to him but it becomes a charity on his part. Sahih Muslim (1552a) 195

M O H A M M A D AYA Z E T A L .

Abū Hurayrah also reported the God’s Messenger saying: Of the dinar you spend as a contribution in Allah’s path, or to set free a slave, or as a sadaqa given to a needy, or to support your family, the one yielding the greatest reward is that which you spent on your family. Sahih Muslim (995)

13.4 Charging penalty on delayed payments If charging any extra amount on loan or debt is strictly prohibited, it is also reported that the Prophet Muhammad (SAW) considered intentional delay in debt payment as an act of tyranny: From Abu Hurairah that Prophet Muhammad (SAW) had said: Delay by a rich person (in payment of debt) is tyranny. Al-Bukhari 1982:175 Thus, Islamic banks have to manage the risk of delayed payments from the customers’ side. Muslim countries have different perspectives regarding delayed payment as per their national fatwa (rulings) (Yaakub et al., 2014). Some Maliki jurists require borrowers to be charitable for the delay in payments. It is also allowed in the Hanafi School of thought to charge penalty on late payments to avoid disadvantage to any party. Same is the opinion of contemporary shari’ah scholars, who also authorized the banks to impose late-fee charges on defaulting customers. The Majma’ Fiqh al-Islami (Islamic Fiqh Academy) is also in favor of charging penalty in business. However, the issue is whether this amount should be added to the Islamic banks’ profits or not? There are three different opinions regarding this issue. In view of Dr. Nazih Hammad, member of the Islamic Fiqh Academy, Jeddah, Saudi Arabia and Dr. Md Ali El-Gari, Shari’ah Board member of the Islamic Bank of Asia, charging penalty is analogous to interest (riba). Therefore, failure of a customer to repay should not only be assessed on the basis of technicalities of the banking sector but also in light of the objectives of Islamic law (maqasid al-shari’ah). Some scholars are of the view that if a borrower is unable to pay a loan for genuine reasons, he should not be punished in any form. In the banking industry, this kind of customer’s loan can be rescheduled (Abdullah, 2018). In the context of maqasid shari’ah, debt or loan is basically a tabarru’at (gratuitous) contract, which is a charity contract used to create ease for those who need money (Abu ‘Arjah and Sabah, 2005). In contrast, Sheikh Muhammad Sadiq al-Dharir, Shari’ah Advisory Council of Islamic Bank Jordan and most of the Shari’ah Committees of 196

S OU RC E S A N D USE S OF C H A R I T Y F U N D AC C OU N T

Islamic banks in Malaysia are in favor of penalty. In their opinion, the banks can use the penalty amount as a part of their income. Dr. Abd Sattar Abu Ghuddah and Shari’ah Council of Accounting and Auditing Organization for Islamic Financial Institutions (AAOFI) are of the opinion that penalty should be charged in case of delayed payment, but this should be deposited into a charity account, and the banks cannot utilize it for their own benefits. Although principally Islamic banks cannot charge more than the debt amount from customers, this can create a problem for banks because a dishonest customer can take advantage of it and drastically affect the bank’s profitability. As per the instruction of the regulator, it is mandatory for Islamic banking institutions to maintain a separate CFA for shari’ah non-compliant income or penalties for late payment (SBP, 2008). Due to the possibility of conflict of interest in the charity fund, the regulator needs to pay more attention to the serious issue. There are chances that these charity funds can be used for the bank’s own benefit. It is an observation that these funds are indirectly used by Islamic banks for their benefit in publicizing their services. As a rule, Islamic banks must utilize these funds within a year but owing to the provision of relaxation, they can keep funds with them for an extra year. This needless delay is a reason to doubt the bank’s integrity. It is compulsory for Islamic banks to make sure that the charity fund amount should not be used by the bank for any of its direct or indirect benefits. Islamic banks do not have the proper mechanism of assessing transparency in a system except that records the inflow and outflow of charity funds (Mansur, 2019). It is important that Islamic banks mention the sources and uses of charity fund amounts, other than zakah (obligatory charity) funds (Haniffa and Hudaib, 2007).

13.5 Regulation of the SBP regarding late-payment charges SBP requires all Islamic banks to create a CFA for shari’ah-non-compliant sources of income and penalties received in lieu of late payments, the amount from which cannot be used for the benefit of Islamic banks. The Prudential Regulation (G-3) of SBP further added that this amount could only be used for charitable and welfare purposes with the consent of the shari’ah advisor and board of directors. The SBP also required Islamic banks to submit a copy of their policies regarding charitable funds utilization to its Islamic banking division within seven days after approval from the board. In case of any amendment in the policy, the same should be intimated to the SBP within seven days from such amendment (SBP, 2008). Islamic banks must maintain proper records of all CFA transactions, which should be disclosed in the financial statements under the head of the statement of sources and use of the charity fund. The charity fund amount can be utilized in the same accounting year (SBP, 2008). 197

M O H A M M A D AYA Z E T A L .

After establishing that all the incomes from any prohibited sources shall be transferred to charity accounts, it is necessary to discuss the criteria for declaring any income as shari’ah-non-compliant.

13.6 Shari’ah screening criteria for Islamic banks Islamic banks in Pakistan do investments subject to the following screening criteria: 13.6.1 Nature of business of the investee company The core business of the investee company should be according to the principle of shari’ah. 13.6.2 Incidence of interest-bearing debt to total assets The interest-bearing debt to total assets ratio should be less than 37%. 13.6.3 Accepted limit of non-compliant investments to total assets The ratio of non-compliant investments to total assets should be less than 33%. 13.6.4 Tolerance level of non-compliant income to total revenue The ratio of non-compliant income to total revenue should be less than 5%. So any income generated against the above set criteria shall be shari’ah-non-compliant, which according to the SBP’s regulations shall be transferred to the CFA. In the following, the researchers discuss to know whether any income is generated by “M” Bank, which is not in conformity with the above criteria, and if so, is it being transferred to its charity account or not, and whether or not “M” Bank discloses its sources and use of funds?

13.7 Sources and uses of the CFA of “M” Bank “M” Bank offers different shari’ah-compliant products. Sale and leasebased products are much popular and attractive to the public. The main issue faced by “M” Bank is ensuring the effective and timely recovery of financing amount from customers. This needs proper monitoring and avoiding the adverse selection of customers. Here the detail of the statement of sources and use of funds of “M” Bank of Pakistan is given to see the transparency and uniformity in its disclosure policy.

198

S OU RC E S A N D USE S OF C H A R I T Y F U N D AC C OU N T

Table 13.1 Statement of sources and uses of the CFA of “Meezan” Bank 2014–2019 (Rs. in 000s)

Opening balance at January 1

2019

2018

2017

2016

2015

2014

1,086

2,398

1,637

10,851

11,899

51,858

49,110

32,376

29,502

24,899

43,562

26,618

9,847

3,396

1,937

2,587

2,666

2,654

5,269

1,150

–

712

1,526

1,785

238 64,464 65,550

166 37,088 39,486

172 31,611 33,248

405 28,603 39,454

775 48,529 60,428

2193 33,250 85,108

(38,100) (4,450) – (7,300)

(30,250) (5,050) – (3,100)

(26,250) (2,700) – (1,900)

(32,867) (2,900) (100) (1,950)

(40,427) (7,200) (1,950) –

(55,409) (15,300) (400) –

– – (49,850) 15,700

– – (38,400) 1,086

– – (30,850) 2,398

– – (37,817) 1,637

– – (4,9577) 10,851

(100) (2000) (73,209) 11,899

Additions During the Period Received from customers on delayed payment Dividend purification amount Non-shari’ah-compliant income Profit on charity savings account

Less: Distribution of Charity Education Health Islamic microfinance Community development Environmental Relief and disaster recovery Closing balance at December 31

Source: Self-constructed based on the information available in financial statements of “M” Bank.

Table 13.2 Statement of the CFA’s disbursement (Rs. In 000s)

Afzal Memorial Thalassemia Foundation The Aga Khan University – Financial Assistance Program Aiwan-e-Sannat O Tijarat Hospital Akhuwat Foundation

2019

2018

2017

2016

2015

2014

–

250

–

200

–

300

–

–

–

–

10,000 10,000

100 –

– –

–

100

150

400 (Continued)

199

M O H A M M A D AYA Z E T A L .

(Rs. In 000s)

Alamgir Welfare Trust International Al Mustafa Trust Rawalpindi Bait Ul Sukoon Baqai Institute of Diabetology and Endocrinology Behbud Association Karachi Bunyad Foundation Lahore / Bunyad Literacy Community Council Bin Qutub Foundation Chakwal Burhani Medical Welfare Association Binoria Welfare Trust Burhani Blood Bank and Thalassemia Centre Burns Centre, Civil Hospital, Karachi Cancer Care Hospital and Research Centre Care Foundation Centre For Development of Social Services Child Aid Association Chhipa Welfare Association Creek General Hospital Disabled Welfare Association Eye Donor Organization Fatimid Foundation Kidney Centre & General Hospital Fatimid Foundation Peshawar Centre Family Educational Services Foundation Fatima Kidney Care Hospital Frontier Foundation Welfare Hospital and Blood Transfusion Service Garage School Gulbahao Hands Health Oriented Preventive Education Health Education and Livelihood Promoter Health and Nutrition Development Society Helping Hand For Relief & Development

2019

2018

–

–

200 100 –

150 – –

– 100

2016

2015

2014

–

300

200

–

150

–

–

– – 100

– – 500

200 –

– –

– –

– –

– –

– 300

200 300

– –

– –

– –

– –

– –

300

200 –

– –

– –

– 250

–

–

150

–

–

–

200

–

–

–

–

–

200 200

100 200

200 –

100 200

– –

– –

200 500 – – 150 –

100 – – – 200 –

– – 200 – 150 –

100 – – 100 100 150

150 – – – 150 150

150 – 200 – 100 100

–

–

500

–

–

–

500

200

350

–

–

–

300 300

– –

– –

– –

– –

– –

300 – – 100

300 – – 100

– – – –

300 – 100 –

– – – –

– 100 500 100

–

100

200

–

–

–

–

200

–

–

–

–

–

300

–

–

–

1,000

200

2017

S OU RC E S A N D USE S OF C H A R I T Y F U N D AC C OU N T

(Rs. In 000s)

Health Promotion Foundation Institute of Business Administration – National Talent Hunt Program Institute of Business Administration – Centre for Excellence in Islamic Finance Ihsan Trust – Related Party Infaq Memorial Trust Idara – Al Khair Jamal Noor Hospital Jinnah Foundation Kiran Foundation Karachi Education Initiative Karigar Training Institute Khwendo Kor Lahore Businessmen Association For Rehabilitation of the Disabled Lady Dufferin Hospital Layton Rahmatulla Benevolent Trust Learning Is for Everyone (L.I.F.E.) School Marie Adelade Leprosy Foundation Manzil Education Organization Markaz e Umeed Medical Aid Foundation (Rahat Kada) Memon Health and Education Foundation Muslim Aid Trust Pakistan Muhammadi Blood Bank Muhammad Shafi Trust Muslim Welfare Centre Mercy Pak Noor Eli Trust National Institute of Blood Diseases National Institute of Cardiovascular Disease Nigheban Trust Okara Patients Welfare Association Omair Sana Foundation Pakistan Association of Blind Pakistan Kidney Institute / Shifa Foundation Patients Aid Foundation – Jinnah Hospital Patients Welfare Association Pakistan Red Crescent Society (for Ultra Sound machine)

2019

2018

2017

2016

2015

2014

500 –

– –

– –

– – – 12,770 13,459 17,284

4,000

–

–

–

–

–

29,400 – – – 100 – – – 200 3,500

28,000 – 300 100 100 200 – 100 200 1,000

25,000 100 – – – – – 100 – 1,000

17,000 250 500 100 100 500 1,297 – – 500

18,000 – – 100 – – 2,368 300 – –

35,000 – – 500 – 500 – – – –

200 – 2,500

– – –

– – –

– – –

– – –

– 300 –

–

100

–

–

100

200

200 100 500

– 100 250

– – –

– – 200

– – –

– – –

200

–

–

–

–

500

– – – 200 200 200 – –

– 200 – 200 100 100 – –

– – 200 200 100 100 – 100

– 100 – – – – – –

– – – 200 – 200 – –

1,000 – – 200 – – 300 –

100 100 – 100 –

100 – 300 300 –

150 – – 100 –

– – – – –

– – – – 100

– – 300 100 200

200

200

–

200

500

250

– –

150 –

– –

– –

– 150

– – (Continued)

201

M O H A M M A D AYA Z E T A L .

(Rs. In 000s)

Pakistan Disabled Foundation Pakistan Association of Deaf Pakistan Eye Bank Parents Voice Association Patients’ Behbud Society for Aga Khan University Hospital Poor Patients Aid Society – Civil Hospital (Karachi) Prevention of Blindness Trust Professional Education Foundation Rashid Memorial Welfare Organization Rising Sun Education and Welfare Society Roshni Homes Trust Rotary Humanitarian Trust – Hawksbay School Saylani Welfare Sargodhian Spirit Trust Shafi Trust SINA Trust Society for Heart Care SOS Children Village Islamabad SOS Children Village Karachi SOS Children Village, Multan The Indus Hospital The Kidney Centre Trust Jamiat Taleem Ul Quran Welfare Society for Patient Care Women Islamic Lawyer’s Forum World Memon Organization Zubaida Machiyara Trust

2019

2018

2017

2016

2015

2014

– 100 200 200 –

400 100 – – 1,000

200 200 – – 1,000

200 200 100 – –

100 200 – – –

– – – – –

100

–

–

–

100

–

500 – 1,000

– – 200

– – –

200 – 500

– – –

– 125 1,000

100

–

–

–

–

–

– –

– –

– –

– –

– 1,000

200 –

100 – – – – 100 100 100 – 150 – 150 – 500 200 49,850

100 200

100 – 100 – 1000 – – – 100 100 – 100 – – – 37,817

– – – 200 1,000 – – – 500 – – – – – – 49,577

– – 200 – – – – – 1,000 200 200 – – – – 73,209

– 300 – 100 200 – – 100 – 100 100 – – 1,000 – – 100 – – – 100 – – – – – 38,400 30,850

Source: Self-constructed based on the information available in financial statements of “M” Bank.

13.8 Statement of CFA’s disbursement 13.9 Analysis “M” Bank’s sources of charity funds are generated from different sources like receipts from customers on delayed payment, dividend purification amount, non-shari’ah-compliant income and profit on charity savings account (Table 13.1). Then these funds are distributed to different deprived sectors like education, health, Islamic microfinance, community development, environmental, relief and disaster recovery as a charity. A major 202

S OU RC E S A N D USE S OF C H A R I T Y F U N D AC C OU N T

portion of these funds were distributed to the education sector and then the health sector. In the education sector, the maximum amount was provided to the Institute of Business Administration – National Talent Hunt Program from 2014 to 2016, while in the health sector, Ihsan Trust – Related party and The Aga Khan University – Financial Assistance Program from 2014 and 2015 were the major beneficiaries (Table 13.2). “M” Bank has no straightforward moving pattern of late-payment charges amount. In 2014, the received late-payment charges were PKR26,618,000, but in 2015, it increased from PKR26,618,000 to PKR43,562,000. There was a decreasing trend in 2016 and again an increasing trend in 2017 and increasing in 2018. There was a substantial increase in late-payment charges in 2019. About a 64% increase from year 2014 to 2015 and a 42% decrease from year 2015 to 2016 have been observed, although “M” Bank’s Islamic financing has been increasing every year from 2014 to 2019. Therefore, the bank is not well in control, and it needs to analyze the causes and solutions to avoid the unstable fluctuation every year. These figures show that “M” Bank is not strongly in control over recovery as the late-payment charges are the part of charity account, and the instability will be a cause for the reduction in “M” Bank’s profit. In other words, the default rate is high, but no clear-cut explanation is given in their report about the exact cause of this fluctuation. The results show that there is uniformity in terms of disclosure practices in “M” Bank of Pakistan for the CFA. “M” Bank of Pakistan discloses all sources and uses of funds in full detail. It mentions in detail not only the addition of charity fund in the year but also segregates their sources of income properly by dividing into different groups like (received from customers on delayed payment, dividend purification amount, non-shari’ah-compliant income, and profit on charity savings account). A similar case with their disbursement is also mentioned sectorwise (education, health, Islamic microfinance, community development, environmental, relief and disaster recovery). Simultaneously, the bank also provides the complete detail of its disbursement amount given to different beneficiaries. Here in the case of disbursement, the donee organizations and individuals are not related to the bank, so the issue of conflict of interest does not arise. It is important that the SBP should bring uniformity in this regard and make sure that every Islamic bank should provide the same detail in their financial statements. This uniformity can alleviate many doubts over their treatment of sources and use of funds.

13.10 Conclusion and recommendations This chapter indicates that “M” Bank of Pakistan has been properly disclosing its sources and use of charity funds in its financial statements as per 203

M O H A M M A D AYA Z E T A L .

the SBP’s regulations. The sources of “M” Bank’s CFA are not only based on late-payment charges but also include dividend purification amount, non-shari’ah-compliant income, and profit on charity savings account, respectively, as disclosed in its financial statements. The charity amounts’ disbursement is made to different deserving sectors like education, health, environmental, Islamic microfinance, community development, environmental, relief and disaster recovery, which is disclosed in the financial statements. Unfortunately, the empirical literature as well as the SBP’s guidelines do not provide any disbursement mechanism or framework for the amounts of the charity accounts. Like corporate social responsibility (Zafar and Sulaiman, 2020), it is proposed that charity disbursement management could lead to achieving social goals by Islamic banks. The upward and downward trends of the late payment charges of “M” Bank over the years indicate that the bank is not looking good with regard to controls and monitoring. The bank should adopt concrete measures to reduce late-payment charges and increase profitability. Although a decrease in charity shows the bank is well in control, still with the increase in the size of an Islamic bank, the volume of charity fund may experience a rise. In light of “M” Bank’s disclosure practice of the sources and use of the CFA, the SBP should devise a comprehensive disclosure policy to be followed by all Islamic banks, whereby not only all the relevant information regarding these banks’ CFAs will be disclosed, but it will also ensure the comparability of these accounts. The uniformity in the disclosure of information can remove many doubts over the treatment of sources and use of charity funds. Currently, the SBP provides mere general guidelines regarding the creation of CFAs by all Islamic banks, where shari’ah-non- compliant earnings are to be transferred. The government can form priority channels of disbursements depending on the current needs of the country. One hint is to follow the government’s sustainable development goals or some national development targets. The only problem with this mechanism is that the funds could move to one specific region of the country. This could be solved by creating brackets in the charity-spending mechanism with respect to essentials and needs, whereby the present government defines necessities, and the essentials are defined by the community of banks. Lastly, the government can frequently fix the portion of the charity fund to be diverted to essentials. Charity funds can be used for welfare. To avoid any conflict regarding the misuse of funds, a separate independent body can be formulated by the government, which will collect all charity funds and use them for infrastructure development in the country, particularly in the area of health, education, and construction of roads and even dams in the case of Pakistan, where water shortage is one of the biggest problems. The funds can also be helpful in the area of microfinance by providing finance to the needy and skilled. 204

S OU RC E S A N D USE S OF C H A R I T Y F U N D AC C OU N T

This can be helpful in reducing poverty by converting the poor from a state of dependency into independency. Here again, the need for a transparent system is mandatory for the best utilization of funds. The study also recommends future researchers to explore the framework that can help in the efficient disbursement of charity income rather than random distribution based on linkages or reputation. Lastly, this study proposes future research studies to integrate the charity disbursement of Islamic banks with the social development of the country. It may help researchers explore whether Islamic banks contribute to social development via charity disbursement.

Bibliography Abdullah, A. (2018). Late Payment Treatment in Islamic Banking Institutions in Malaysia: A Maqasid Analysis. International Journal of Academic Research in Business and Social Sciences, 8(11), 30–43. Abu ‘Arjah, S. M. and Sabah, M. M. (2005). Ahkam Radd al-qard fi al-Fiqh alIslamiyy. Majallah al-Jam’ah al-Islamiyyah, 13(2), 103–148. Al-Qurṭubī, al-Jami’ li Ahkām al-Qurān, 5:227–230. Al Rahahleh, N., Ishaq Bhatti, M., and Najuna Misman, F. (2019). Developments in risk management in Islamic finance: A review. Journal of Risk & Financial Management, 12, 37. https://doi.org/10.3390/jrfm12010037 Awang, S. A., Muhammad, F., Borhan, J. T., and Mohamad, M. T. (2017). Ismā‘īl bin Kathīr al-Damsyīqī, Tafsīr al-Qurān al-‘Alīm (Egypt: Maktabah al-Tawfiqia (2000), 143, 45(1), 141–172. Ayub, M. (2007). Understanding Islamic Finance. Chichester: John Wiley &Sons Ltd. Haniffa, R. and Hudaib, M. (2007). Exploring the Ethical Identity of Islamic Banks via Communication in Annual Reports. Journal of Business Ethics 76(1), 97–116. Harrison, H., Birks, M., Franklin, R. and Mills, J. (2017). Case Study Research: Foundations and Methodological Orientations. Forum: Qualitative Social Research, 18(1), 1–17. Hassan, K. and Cebeci, I. (2012). Integrating the Social Maslaha into Islamic Finance. Accounting Research Journal, 25(3), 166–184. Ibn Kathīr, Tafsīr al-Qurān al-‘Alīm, 1/2:54. Ibn Kathīr, Tafsīr al-Qurān al-‘Alīm, 1/2:301. Mahmood Matraji, The Translation of the Meanings of Sahih al-Bukhari, 3:441. Mansur M. (2019). Charity Funds in Islamic Banking Institutions (IBI) – A Conflicting Policy. Journal of Islamic Banking and Finance, 36(2), 48. Meezan Bank Financial Statement 2019. https://www.meezanbank.com/ financial-information/ Mujahid, A. M. “Tafsir Ibn Katsir” / Abridged by a Group of Scholars under the Supervision of Shaykh Safi Ur Rahman al-Mubarakpuri, Chapter 9, Hadith 658 (9:658). Mujahid, A. M. “Tafsir Ibn Katsir” / Abridged by a Group of Scholars under the Supervision of Shaykh Safi Ur Rahman al-Mubarakpuri, 1:112–114. Mujahid, A. M. “Tafsir Ibn Katsir” / Abridged by a Group of Scholars under the Supervision of Shaykh Safi Ur Rahman al-Mubarakpuri, 5:202.

205

M O H A M M A D AYA Z E T A L .

Mujahid, A. M. “Tafsir Ibn Katsir” / Abridged by a Group of Scholars under the Supervision of Shaykh Safi Ur Rahman al-Mubarakpuri, 4: 239. Mujahid, A. M. “Tafsir Ibn Katsir” / Abridged by a Group of Scholars under the Supervision of Shaykh Safi Ur Rahman al-Mubarakpuri (Riyadh: Darussalam Publishers & Distributors, 2000). Jurnal Usuluddin, 45(1), 141–172. Neale, P., Thapa, S. and Boyce, C. (2006). Preparing a Case Study: A Guide for Designing and Conducting a Case Study for Evaluation Input. Watertown: Pathfinder International. Siddiqi, A. H. (1999). “Sahih Muslim”; Arabic-English, Adam Publishers & Distributors., 1999, Hadith number 31 of chapter 1 (1:31) hereafter the first indicate chapter and second Hadith or statement number. Siddiqi, A. H. (1999). “Sahih Muslim”; Arabic-English. India: Adam Publishers & Distributors, 2:91. https://sunnah.com/muslim. State Bank of Pakistan Islamic Banking Department, Instructions for Shari’ah Compliance in Islamic Banking Institutions. Annexure 1 of IBD Circular No. 02 of 2008. www.sbp.org.pk. Ta‘Widh and Gharamah (Shari’ah Resolutions in Islamic Finance). Yaakub, E., Adil, M. A. M., Husin, A., Muhamad, M. D., Shahruddin, M. S., Yazid, N. H. M. (2013). Late Payment Charge in Islamic Bank. The 5th International Conference on Financial Criminology (ICFC) “Global Trends in Financial Crimes in the New Economies,” 382. Kuala Lumpur, Malaysia. Yaakub, E., Adil, M. A. M., Husin, A., Muhamad, M. D, Khalid, M. M. (2014). A Revisit to the Practice of Late Payment Charges by Islamic Banks in Malaysia. Jurnal Pengurusan (UKM Journal of Management), 42, 185–190. Yin, R. K. (2003). Case Study Research: Design and Methods. Thousand Oaks, CA: Sage Publications. Zafar, M. B. and Sulaiman, A. A. (2020). Measuring Corporate Social Responsibility in Islamic Banking: What Matters? International Journal of Islamic and Middle Eastern Finance and Management, 13(3), 357–388.

206

14 ISSUANCE OF MUSAWWAMAHBASED CARD BY ISLAMIC BANKS AS AN ALTERNATIVE TO CREDIT CARD Opportunities, challenges and prospective solutions Imam Uddin, Muhammad Shujat Saleem, and Abdur Rahman Aleemi 14.1 Introduction In today’s world, banking is an integral and perhaps the most important component of the financial services industry. Given the sensitive nature of their unique services, banks today are becoming exceedingly sophisticated and highly regulated. However, at the same time, banks are continually striving to introduce more effective and innovative products and services to their customers. Apart from their fundamental intermediary functions and certain basic products, such as saving and current accounts, personal loans, house and car financing, online banking, ATM facilities, import/export payments (treasury functions), home remittances, debit and credit cards, and internet banking are common examples. However, in certain societies (particularly in the Islamic world), the traditional products and services mix of conventional banking did not get much acceptance from the viewpoint of interest (Riba) prohibition in the teachings of Islam. Thus, Islamic banking, since its humble beginning has gained much popularity against its conventional counterparts in the last couple of years. As Pakistan is one of the countries with a Muslim majority population, Islamic banking is growing rapidly at a very fast pace. Although Islamic banking does not have a long history in the country as the first full-fledged Islamic bank (Meezan Bank Limited) started its operations in 2002, yet the people accepted it and found its operations to very closely follow the teachings of Islam. Despite Islamic banks offering many shari’ah-compliant alternatives to conventional banking products and services, there has been no shari’ahcompliant alternative available for credit cards yet. This is a significant gap and is intended to be traversed in this study. DOI: 10.4324/9781003050209-14207

IMAM UDDIN ET AL.

A credit card is one of the most common ways of credit purchases (fixed up to a certain limit) whereby the customer has to payback and return the amount owed by him until a certain time period (predefined date) to avoid payment of interest. And if he/she is unable to do so, an interest is charged over the outstanding amount. Credit on interest is an issue for Islamic banks and shari’ah scholars as it contradicts with the basic teachings of Islam. And thus, so far, no considerable achievement in the issuance of a credit card from Islamic banks have been made not only in Pakistan but globally. There are several verses of the glorious Qur’an and many sayings (Hadiths) of the Prophet Mohammad (Peace be upon Him) that prohibit any form of interest (riba). The interested reader in this regard is advised to see the appendix for a detailed account of riba prohibition in the Holy Qur’an and Hadiths. However, in the next section, a brief historical overview of credit cards is provided followed by the injunctions and mechanisms of musawwamah-based financing to develop a deeper understanding of the same.

14.2 Credit cards through history The idea of a ‘credit card’ can be traced as far back as the 1920s, whereby departmental stores’ credit was popular. However, the first credit card was issued by Franklin National Bank in 1951. Following the lead, in 1958, Bank of America launched a first consumer-based credit card program namely ‘BankAmericard’ with revolving credit feature, which was later renamed as Visa credit card in 1976. Similarly, in 1966 ‘Master Charge’ (initially known as ‘Interbank’) started its operations which later became well-known as ‘MasterCard’. The emergence of these companies significantly boosted the conventional credit card industry (Hussin, 2011). However, on the other hand, Islamic credit card is a relatively new product and is still in its infancy. The first Islamic credit card was issued by AM Bank of Malaysia recently in 2001, namely AL-TASLIF Card. Similarly, in 2002, ABC Islamic Bank of Bahrain issued AL-BURAQ Islamic credit card (Bilal & Meera, 2015). Initially, in the case of Malaysia, the AL-I’nah model was adopted for Islamic credit cards; however, in 2008, a tawwaruq-based model was introduced by Bank Rakyat. Afterward, in 2009, Eoncap Islamic Bank Berhad introduced the Ujrah model and HSBC introduced the Amanah-based model in the same year (Noor & Azli, 2009). The aforementioned instruments and financing modes have their merits and de-merits and has been debated since long among scores of shari’ah scholars and banking practitioners. However, no such attempt has ever been made to the best of our knowledge with a musawwamah-based model of credit card issuance. Similarly, in Pakistan, to date no such attempt has been made to issue an Islamic alternative to the conventional credit card; however, there are several workable plans proposed by various banks that are discussed later in this chapter. The only exceptional case we have is that 208

M U S AW WA M A H C A R D

of SAADIQ credit card by Standard Chartered Bank (henceforth SCB), which follows the murabaha model and is highly debatable in terms of shari’ah compliance.

14.3 Conditions of musawwamah financing Originally, musawwamah is not a financing instrument but is rather a kind of sale in Islamic jurisprudence. In a musawwamah-based sale, the seller is not obliged to disclose his cost to the buyer. We propose that for humanity in general and Muslim ummah in particular, away from riba, musawwamah-based transactions may be used as an alternative to interestbased conventional credit cards after taking into account the following conditions of a valid sale from the shari’ah viewpoint, which are as follows: 1 2 3 4 5 6 7 8 9 10

Existence Ownership Possession Instant and absolute Specification Certainty of price Certainty of delivery of subject matter Halal goods Property of value Unconditional sale

However, it should be noted that the first three conditions are not needed to be fulfilled in the case of salam- and istisna-based transactions. The extant literature clearly highlights that a lot of academic work has been undertaken on conventional credit cards. However, little to no work is available related to the issuance of Islamic alternatives to credit cards. Very few authors have tried to work on the issuance of Islamic credit cards with various models as indicated earlier. However, no research work has been done on a musawwamah-based alternative to interest-based conventional credit cards. Thus, a research gap exists as the Holy Book of glorious Qur’an prohibits riba. It is believed that Muslims generally wish to avoid riba-based credit cards, but at the same time, the convenience and facilitation associated with the use of a credit card is also desired. Moreover, this research adds value to the existing literature of Islamic banking and finance in terms of the feasibility of a musawwamah-based credit extension. Thus in light of the above discussion; this chapter is aimed at exploring the potential opportunities and associated problems/impediments to the issuance of a musawwamah-based alternative of credit cards in Pakistan. In the next section, a brief overview of relevant literature is provided to embed and present our case in light of recent developments in scholarly works. 209

IMAM UDDIN ET AL.

14.4 Relevant literature Today, credit cards are used as an essential and one of the most convenient modes of payments. People use credit cards for multiple reasons, for example, to obtain cash advance, credit facility, and make easy payments, and it has also become a source of prestige. The basic amenity a credit card provides is to buy or purchase now and pay it later (Amin, 2012; Choo et al., 2007). Technically, credit card provides plastic money in which the customer can use the credit facility delegated by the concerned bank (Choo et  al., 2007). The advantages of credit card transactions include security, convenience, and cost-effectiveness. It also provides a level of comfort and sometimes many other benefits to users (Billah, 2003). The credit cards recently became popular in scholarly debates and of concern among shari’ah circles, whereby some are strictly against their usage because of the associated interest costs (Bakhshi, 2006). Thus, it is necessary to address this issue by finding a sharia’h-compliant alternative of the same. As Islamic banking is getting acceptance throughout the Islamic world, researchers are striving in every product line (of conventional banks) to find a shari’ah-compliant replacement of that product or service. A credit card of a conventional bank is also one of these products and is increasingly becoming the focus of intensive research these days. Shari’ah-based credit cards or Islamic credit cards are newly introduced products in credit card history; in 2000, AM Bank of Malaysia issued the very first Islamic credit card known as the Al-Taslif card, followed by the ABC Islamic Bank in Bahrain in 2002, by issuing the Al-Buraq credit card (Bilal & Meera, 2015). The aforementioned Malaysian Islamic credit cards initially adopted the ‘Bay Al-I’nah’ model. However, Al-I’nah came under intense criticism from shari’ah circles and is still debated and contented by many in terms of shari’ah compliance. Thus, in 2008, Bank Rakyat introduced a ‘tawarruq’-based Islamic credit card. Similarly, in 2009, EON CAP Islamic Bank Berhad introduced a credit card based on the ‘ujrah’ model. In the same year, HSBC introduced their credit card based on the ‘amanah’ model of financing (Noor & Azli, 2009). As for the difference between an Islamic credit card and a conventional credit card, considerable interest will be charged on conventional credit cards. Precisely, there are three basic differences between an Islamic and a conventional credit card. Firstly, there is no compounding interest allowed in an Islamic credit card as compared with a conventional card. Secondly, conventional profit margins on a credit card is not predetermined, whereas Islamic profit margin on a credit card should be fixed for the whole contract period. Thirdly, a conventional credit card does not follow the shari’ah principles. On the other hand, Islamic credit is guided by shari’ah principles. This third principle was first validated by the doctrine of bay Al-inah in the case of Malaysian Al-Taslif card (Kazi, 2002). 210

M U S AW WA M A H C A R D

The contract of bay Al-inah works on two different dimensions, i.e. one is Bay al-Mutlak (cash sale) and the other is bay Bithaman Ajil (deferred sale) (Darwish, 2003). The first one is the bank’s agreement to sell an item or goods to the customer at an agreed price and the second one is an agreement in which the customer is selling back the item or goods to the bank at a lower and agreed price. The difference is the profit for the bank on an agreed and predetermined basis. But some scholars from the Middle-East do not recognize the doctrine of bay Al-inah and they decided that the solution to avoid the riba is to exercise the acceptable right of charging for the provision of a financial guarantee called the guarantee system (Darwish, 2003). Similarly, transactions on an Islamic credit card are only applicable and allowed for ‘halal’ products and services and are strictly prohibited for any ‘haram’ activity, services, and products from a shari’ah point of view.1 In addition, Islamic credit cards should also have several other Islamic features like sadqah, zakat, and waqaf, among others (Amin, 2012). It is interesting to note that in Malaysia, in particular, both Islamic and conventional credit cards have more or less the same features, and however, both are entirely different in terms of fee charging, principles, and operations (Amin, 2012). Moreover, Islamic credit cards are also significantly contributing to the economy (Mansor, 2005). Muslim scholars mostly agree that it is the duty of Islamic banks to develop the socio-economic status of the Muslim Ummah by providing different and viable financial services (Metawa and Almossawi, 1998). Similarly, it is important for Islamic banks to operate on the basis of Islamic ethical norms (Hamid & Masood, 2011). Therefore, all financial activities and services must be according to the basic principles of Islamic jurisprudence (Abdullah et al., 2012). Islamic financial contracts have certain specific values such as consideration of justice in the financial process, the prohibition of gharar (excessive risk) and riba (usury), and restraint from those activities that are not permissible by shari’ah and are socially disliked (Gait & Worthington, 2008). Similarly, Islamic scholars also argue that Islamic mode of financing are largely asset based, which enhances financial stability and limits episodes of downturns (Shayegani & Arani, 2012). Likewise, Ahmed (2010) argues that the system of Islamic finance is capable of increasing risk-sharing, promoting productive activities and creating a stable monetary system. This also leads to support the distribution of wealth, which ultimately leads to the stability of nations and economic prosperity. Resultantly, in recent years, high acceptance can be observed for Islamic banking and finance in several countries including developed and non-Muslim populated countries as well, such as Australia, Singapore, the United Kingdom, and the United States (Amin, 2007). No doubt, one can see that there exists a subtle and mostly unobserved competition within the Islamic banking industry. To develop products and 211

IMAM UDDIN ET AL.

services that could be different and compatible with the conventional ones is a highly demanding and innovative task. Risks and uncertainties about the response and demands of customers are prevalent. However, and still, there is a lack of empirical evidence on the value addition of many instruments of Islamic banks including and not limited to credit cards. Existing surveys regarding the use of Islamic credit cards mostly provide mixed evidence. For instance, Dali and Hamid (2007), Dali et  al. (2008) and Mansor and Che Mat (2009) contented that income was an influential predictor for the use of Islamic credit cards among existing users. On the other hand, Choo et al. (2007) found that only employment has a significant influence on the probability to choose an Islamic credit card. It is essential to document the various aspects of these instruments to identify and determine the potential benefits of these innovations both for individual customers and the economy as well.

14.5 Tools and methods Keeping in view the nature of the research, we used the qualitative method for collecting data through open-ended questions by conducting semistructured interviews from shari’ah and business heads of five full-fledged Islamic banks in Pakistan. In addition, our research is concerned with the feasibility of launching a musawwamah-based alternative to credit cards. All shari’ah and business heads of Islamic banks were considered as the target population for this research. A list of these banks is provided below: 1 2 3 4 5

Meezan Bank Banks Islami Dubai Islamic Banks Al-Baraka Bank MCB Islamic Bank

However, a total of ten (10) respondents were conveniently sampled from the given population. Two respondents (a business head and a shari’ah head) were selected from each bank. Their expert opinion was obtained through proper invitations and informed consents were duly filled. Every expert was asked three open-ended questions regarding the potential opportunities, the issues and the possible solutions respectively. Their responses were duly recorded, and in most cases, translated into English from the native language of Urdu. Due care was taken and language experts were consulted to avoid issues during the process. Most of these responses were reported verbatim against every question in sequential order, starting from opportunities, followed by the potential problems and then the possible solutions. In the next section, we present these experts’ responses verbatim, followed by a brief discussion and conclusion. 212

M U S AW WA M A H C A R D

14.6  Experts’ opinions and judgments This section presents the data gathered by conducting semi-structured interviews from ten (10) respondents of the five (5) full-fledged Islamic banks in Pakistan. Question 1: What are the opportunities for the issuance of a musawwamah card in Pakistan? A respondent from Al Barakah Bank said, the summary of which is as follows: Currently there are several types of models existing in the Islamic banks like SADIQ Islamic credit card but there is a question mark on the acceptability of that card because our Shari’ah board does not recommend it, although it is functional in Bahrain. Here in Pakistan only Standard Charted is offering an Islamic credit card that is based on Wakalah structure, but the model that you have proposed is also taken into consideration by various banks and quite enough of homework has been done by those banks. For instance, Meezan Bank has proposed another product which is based on Murabaha and it is almost ready to be launched in the market. On the other hand, Faisal Bank is also working on it and most probably Faisal Bank would be able to launch the industry’s second credit card after Standard Charted. As far as scope of the card is concerned, I do not think that, there is much scope or acceptability of the card in our society. Another respondent from the same Al Barakah Bank shared his thoughts that: There is ample opportunity to serve a huge Muslim population who is using conventional credit cards for their daily life. However, basic question is that how one can serve in this situation when clients are not willing to pay an extra amount for these products. In the first step bank has to convince them towards Islamic mode of financing, and then take the second step, i.e. make them as target. Otherwise it is quite difficult to justify all the steps. The same question was answered by a respondent from BankIslami Pakistan Limited (BankIslami): Credit cards can be used anywhere, anytime at POS and there is no requirement of the person to be deployed to swap card. Normally when we declare something is alternative of something, then we try to keep the same cost although their structure can be different. And all the features which existing product have should also be claimed 213

IMAM UDDIN ET AL.

by the new product. And thus, this new card (Musawwamah based credit card) can be a better alternative of conventional credit card. Another respondent from BankIslami replied to the question as follows: Yes, this card (Musawwamah based credit card) can be the best replica of conventional credit card offered by conventional banks. All the card holders can be convinced in this regard. There is a huge potential in the market. If you go to a retail store you can see there that things are being sold with low costs during sales and promotion campaigns. People are crazy to buy things and most of them are using credit cards to buy their stuff. Hence, there is a chance to capture this low-income segment. A respondent from Meezan Bank Limited responded as follows: Of course, there is a potential for Islamic credit cards because users exist in the market. Those who have religious thoughts willing to have Islamic cards. The process is not new, and it already happened several times in the past. Certain attempts are made by some banks to introduce this kind of cards due to high demand. It was also discussed in different forums by the course of time. And the second respondent from the same bank commented as follows: On daily basis people use credit cards to purchase different types of commodities. This is the reason this card (Musawwamah Based credit card) can be beneficial for the low-income segments. Especially those who are routine users of grocery from large type of retails stores. One respondent from Dubai Islamic Bank responded as follow: Although there is an ample opportunity to introduce Islamic credit cards in the market yet there is not a single Islamic credit card in the market except that of Standard Chartered (SCB) SADIQ Credit Card. If someone is willing to introduce a full-fledged Islamic credit card then obviously, it could claim the first mover advantage. SCB’s SADIQ tried its best but there are still some reservations as far as Shari’ah principles are concerned. Those who are active conventional credit card users, may be convinced to convert towards the Islamic credit cards… Of course there are a lot of opportunities in the current market.

214

M U S AW WA M A H C A R D

And the second respondent commented as follows: Yes, you can offer this product to existing credit card users as there is no Islamic card in the market. Customers are willing to accept this card and bank can earn more revenue by this product development strategy. In past, almost all of the Islamic banks tried to introduce their Islamic cards but was not been able to launch these in the market. However, there is a lot of possibility for them to introduce Islamic cards in the market because of the high demand of this product. When the same question was asked from a respondent from MCB Islamic Bank, he said: Yes, there is an opportunity for introducing Musawwamah Card but as far as the question of introducing this card with the Musawwamah outlets; it would be very difficult as the bank would need to deploy their representatives to each Musawwamah outlet which would definitely increase the cost of the project. Furthermore, there would be a constraint that the Musawwamah card would be usable only at proposed Musawwamah outlets. While another respondent from the same bank replied that: It would be rather a better option to introduce Musawwamah Card alone with the incorporation of Musawwamah Outlets as the latter option would not be cost effective for Islamic Banks because it should also be considered here that Islamic Banks do not have unlimited sources for their rewards i.e., they are not permitted to charge the interest. Question 2: What are the problems/impediments to the issuance of musawwamah cards in Pakistan? We got the following response from a respondent from Al Barakah Bank. All those banks who did work on it, are not ready to launch Musawwamah card because of its complexity in transaction execution, i.e. on every transaction one has to disclose his profit which is quite difficult to manage. Usually three aspects are taken into consideration while executing this transaction, firstly what is the amount of that credit sales? Secondly what is payment period of that? Whether it will pay back in three months, six months or after a year, how many installments he will pay, for that perspective the profit mechanism

215

IMAM UDDIN ET AL.

gets different. For example, a customer says that I will pay in 45 days on Musawwamah based transaction while same scenario is conventional credit card which is not different. Conventional banks determine in advance whether profit would be charged or not because if customer pays within 45 days there will be no profit and if he fails to pay within 45 days, profit would be charged but problem is here in Islamic credit that how to determine profit, whether it would be charged or not at the time of sale and how much profit would be charged? In my opinion, there is a drawback in the issuance of Musawwamah card as it involves quite lengthy and complicated processes. While the second respondent shared in detail his opinion as follows: (If) you want to launch a credit card, the first question that you will face is that what the associated hidden costs are) People tend to be afraid of these hidden costs now a day. How you will address this, is a challenge. Because every credit card issuing bank has disclosed their cost somehow. But as far as your product is concerned you must have to disclose your product cost, but at the same time you are not liable to disclose the acquisition cost of that product. Before launching your product, you have to keep in mind something like, what is our target market, who will be the consumer of our product, what type of competitors already exist in the market and what type of similar products are available in the market? Another challenge for you is how you convince a customer who is already using conventional credit card. How you convince them that your card is different from conventional banks’ card. I have been using different credit cards and I am mostly satisfied with them. I receive calls on daily basis regarding their products and services so how can you convince me to switch? – Product positioning should be like that your customer can easily avail what you are offering to them. In addition, operational costs should also be a consideration. One of the biggest challenges is that credit card market is already saturated and it is quite difficult for new entrance especially for a model like you are suggesting. Everyone holds different bank cards then why your card? You have to sort out that who are your potential clients, whether they are educated about this product. Then you have to decide which model to use. In the type of Murabaha, one has to decide about the profit from the very first day according to the installment plan… If your financing method would be same then you would be able to compare profit easily. On the other hand, pricing should be linked with one-year KIBOR rates. For the reasons being that Islamic banking does not have their own Murabaha pool although SBP is working on it. When they will have their own Murabaha 216

M U S AW WA M A H C A R D

pool they will be able to initiate their own pricing. Another challenge is what you are offering is been already offered by conventional banks. Similarly, you have to make this card cost effective. Because conventional banks are charging up to 22% on their credit cards. And the challenge for you is to offer the same product on 16% or 18%, so your cost can be matched with income. When we asked the same question from a respondent from BankIslami, his response was as: If you launch a new product and it does not have those features which the existing products have, then resultantly, the new product is headed for failure. And there can be limited scope of that if it is not been able to beat that existing product. Some people may opt to use it but it cannot replace the conventional one because credit card can be used everywhere and if you try to deploy correspondence everywhere then the cost will obviously go up and resultantly, your product will be expensive. So, this model will not work. Meezan bank when started its Umrah and they placed their banners outside, SBP called them and inquired that how are they doing this? Ultimately, they have to take the travel agent onboard, who complained about Meezan bank and claimed that the bank does not have a travel agent license. Another problem is of huge costs involved. We should analyze first that what credit card does? Note down the features of the credit card and work out accordingly. Another respondent from BankIslami said that: It is not as easy as it seems, there is huge cost required. Because, when you try to compete those established conventional banks who are working since long, you have to do something new which is not available in the market. You can face regulatory issues somewhere, most importantly you will have Shari’ah conflict most of the time as credit card is a difficult product as for as Shari’ah compliance is concerned. Furthermore, you will have definite operational challenges because you are in a very challenging product development phase. Besides of this there is huge cost required to launch this new card and it is not easy for any bank to manage these finances. A respondent from Meezan Bank Limited replied to our question in following words: Normally the first challenge rises in the shape of possession of the goods. Means if a bank is selling something, it has to be purchased first. Otherwise the transaction will be void as far as Islamic 217

IMAM UDDIN ET AL.

principles are concerned. You cannot generate profit from it because your sale is void. Practically, no one can resolve the issue of this procession and ownership. If cost is not justified as compared to the income, it will not be feasible to the bank. While another respondent from Meezan Bank said: How do you convince customer to purchase your product when he is already using a similar kind of product? Another challenge is that you cannot offer this product everywhere since you cannot generate profit. Islamic Credit card model that are currently in the market is so much tricky and we are not thinking about these. If we talk about Sadiq Islamic card, there is no consensus among Shari’ah scholars. This is the reason we could not introduce Islamic credit card in local market. As you know that offer and acceptance is a mandatory condition in sale agreement. How it will be done in your case? It is quite difficult to get profit from this sort of target market. The following was the reply of our question by a respondent from Dubai Islamic Bank: This model is not as easy as it seems. Because there are a lot of confusions incorporated in this model. The main issue here is offer and acceptance. Another issue is that no retailer would be ready to make another separate counter for you because that may disturb their operational business model. On the contrary, we cannot make our own outlets because it will become a regulatory issue. Regulators will not allow us to trade like this. Despite of that, there are several operational issues involved here like, huge system development cost, licensing issues, franchise costs and loyalty costs etc. On the other hand, the second respondent from Dubai Islamic Bank stated that: There are a lot of challenges involved here in issuance of this type of Islamic card. For instance, there is a huge cost required. Workforce, franchises cost, system development challenge, call center issues, price mechanism, regulatory issues, marketing issues etc. despite of that. And we got the following answer from a respondent from MCB Islamic Bank: As such there would be no regulatory issues in issuance of Musawwamah card in Pakistan because the law is one and the same for 218

M U S AW WA M A H C A R D

all, but if we talk about the risk and rewards, conventional banks charge penalty to their customer for late payment which is interest and so is prohibited (haram) in Islam therefore, for Islamic Banks there is no option as reward of their service. So, this could be an obstacle in the issuance of Musawwamah Card. The second respondent from MCB Islamic Bank responded that: I think there may not be many regulatory obstacles in Pakistan for the issuance of Musawwamah Card. However, other different operational issues can be faced in issuance of the card. These issues can be system development, human resource and franchise cost etc. Another big issue to convince those who are using conventional cards and they are satisfied with their product. And our final question regarding solution was that: Question 3: What are the prospective solutions to the problems faced in the issuance of musawwamah cards in Pakistan? A respondent from Al Baraka Bank said: In the case of Murabaha based transactions, there is a general undertaking, whereby banks authorize its customers to purchase specific halal products on behalf of the bank and upon swap of the card, bank offers those commodities to be purchased from the bank. This is how sales are generated and pricing is being done. Then customer has to decide whether payment should be lump sum or it should be deferred basis. This is one way of doing things in a Shari’ah compliant manner. The second respondent responded to our question as follows: Elements which make a transaction Shariah compliant, should be taken into consideration everywhere—at every step, which is a huge challenge. And when we asked the same question from a respondent from BankIslami, his answer was: A promising solution at the top of my mind is TAWARUK; which is being currently practiced in Malaysia. Tawarruk is what, you give a credit line to the customer. And as he uses that line, a fee is being charged. For instance, you buy something from the market and sell to your customer on profit and your customer then sells it again in the market with higher profit. Simply, if you buy something with 219

IMAM UDDIN ET AL.

rupees 100, sell it to the customer on 105, and the customer sells the same thing on Rs. 100 and that hundred rupees plus 5 rupees from his own side has to return back to the bank. This is one way of doing it. Another method is that profit is determined at the very start point. And after completion of the period if a profit is earned, say rupees 20, then you can give your customer rupees 15 as rebate and balancing should take place. This can become the best replica of credit card currently running in the market. The second respondent from BankIslami said: In my opinion, the best solution could be the Malaysian model of Tawarruk. We got the following answer from a respondent from Meezan Bank that: There can be a centralized payment arrangement. For instance, if we sell a laptop to the customer. So the laptop should be first brought into the Meezan bank. Where proper inventory tagging should be done and then sell or dispatch the same the clients wherever in Pakistan. And in this way, the matter of possession and ownership may be resolved. This is the way you can manage this problem. While another respondent said: If we execute a buy-sell transaction like if I say I want to sell my glasses on credit whereby the payment schedule can be different. In month time period, you can charge different amount, a two-month price will be higher and so on… there is no problem in that. Another suggestion could be that you can make contractor arrangement as Silk bank make has an arrangement with HUM ART. With collaboration they are giving some discounts as well. This can be a credible way for daily basis. You can make for example, DARAZ as an agent of yours and it may execute all offers and acceptances on your behalf. The first respondent from Dubai Islamic Bank answered our question as follows: Best product you can introduce, in my opinion, is Musawwamah grocery card, as there are some foreign Islamic bank already issuing this type of cards to their customer for purchasing grocery. Whereby the apply Murabaha as a mode of financing. This type of product can also be offered here in Pakistan. 220

M U S AW WA M A H C A R D

And the second respondent from the same bank said: Best solution of all of this is to have a centralized payment system, whereby all the Islamic banks should the members of such a system. Once a transaction is performed anywhere, the system should be able to book a liability as per payment schedule. MCB Islamic Bank’s respondent replied that: We can suggest an option of Qarz–e-Hasanah (Loan against no interest charging) in which the penalty amount charged to the customer for late payment are then given away as charity. This model is currently adopted by Standard Chartered Bank and Dubai Islamic Bank. An alternative solution could be the issuance of a Murabaha Card instead of Musawwamah Card because in Murabaha Mode of Islamic financing cost plus profit should be the term of pricing (which would be needed in grocery purchasing by customers especially regarding the small value items) while in Musawwamah Card, customer can argue as the prices would be higher but the cost would not be disclosed to them. While another respondent from MCB Islamic Bank said that: I would rather propose a card based on Murabaha mode of Islamic Finance as the same fits in the case of grocery purchases. Customers can demand for the disclosure of cost. Qarz-e-Hasanah can be the possible solution for late payment surcharges because without a penalty for late payments, you can’t bound the customers to pay on time.

14.7 Conclusion To find out the opportunities, challenges, and possible solutions for the issuance of a musawwamah-based credit card alternative, we interviewed ten experts from the Islamic banking industry. The responses of all respondents were more or less the same. After the survey, a consensus was reached most of the experts shared from the positive reviews of the experts on the possibilities and opportunities for launching a musawwamah-based alternative to a credit card that we have proposed. Most of them stated that definitely there is a huge potential market to be served in the case of Pakistan, which is generally of a low- or medium-income level. People in cities especially have a general tendency for buying using credit cards. At the same time, most of the population have a general tendency of religious thoughts that can be taken as an opportunity to launch such an alternative credit card. 221

IMAM UDDIN ET AL.

On the other hand, if we talk about the potential problems that may arise operationally and also from the shari’ah perspective, there are several issues that need to be considered. For example, 1 General public awareness ought to be created to convince the masses toward the acceptance of an Islamic alternative to the credit card. This is necessary for the reasons being that generally peoples’ perception is that it costs them more than the conventional banking products or services. 2 For grocery shopping, people tend to know the cost of the products they are likely to purchase; therefore, musawwamah cards would not be suitable; instead, murabaha cards may be a better alternative. 3 An alternative to the original product should be equal or almost equal in terms of its costs and benefits to beat the existing product and lead the market. 4 Conventional credit cards offer a 45-day time to pay back the principal amount to avoid interest while in Islamic cards, prices of products could be based on different payback periods. So, the offer and acceptance process might get lengthy and could be different for each client. 5 Huge costs are associated for merchant acquisition cards from Visa and Master Card. 6 It will also be a factor of incurring costs to deploy correspondents at each supermarket or any other outlet but as for conventional banks, it is not the case. 7 There is a huge system development cost to be borne whenever a new product is launched. This is not an easy task even for a large bank. 8 The product may not be in compliance with the rules of Islamic financing. This problem would be very difficult to resolve in the proposed musawwamah-based model. 9 Conventional credit card can be used everywhere, while the proposed musawwamah card has a limited scope for operations. 10 It would be quite difficult to convince retailers to open a separate counter for you, they cannot afford to disturb their business operations neither you can go to another outlet as there would be regulatory issues and cost factors as well. 11 There are several operational issues, such as huge system development costs, licensing issues, franchise costs, loyalty costs, call center setup, price mechanism, etc. As far as potential solutions are concerned, some experts suggested the best model of financing could be tawarruk, which is already in place in Malaysia. Murabaha-based transactions could also be effective in this situation. Another possible solution suggested was that a contract could be made with platforms like DARAZ and other similar entities that will execute the service. 222

M U S AW WA M A H C A R D

One suggestion was to develop a centralized payment system by all Islamic banks. Qarz-e-hasanah was also suggested as a potential solution in this regard in which penalty could be charged and then given away as charity. Further, a survey of the existing credit cards offered by conventional banks would explain their mechanism and in-depth knowledge. And so, it is possible to develop a better alternative product to deal with the competition. 14.7.1 Recommendation After analyzing the answers of all respondents, we would like to suggest the following recommendations. 1

2

3 4 5 6

Due to huge costs and several operational issues associated in the execution of musawwamah transactions in the form of an Islamic credit card, currently, it may not be feasible for the Islamic banking industry to launch such a product. A possible solution could be that all Islamic banks should have a common platform where all musawwamah-based transactions can be executed. This can be achieved by arrangements with superstores, vendors, and manufacturers that they will serve as an agent of the banks when musawwamah card holders want to use their card. In that case, it may also be less costly for Islamic banks. Banks can also provide the Qarz-e-Hasna model instead of the musawwamah model. It is more feasible and cost-efficient. Also it has relatively less operational issues. The murabaha-based model can also be used, but it can have similar cost and operational issues like the musawwamah model. A committee consisting of eminent Islamic scholars of Pakistan and the heads of the Islamic banks should be formed to discuss the best possible solutions and mechanisms for such an alternative. There is a need in Pakistan to raise awareness on the financial destruction associated with interest (riba).

Note 1 Recently Meezan Bank in Pakistan refused and disallowed payments for Netflix on their debit card for shari’ah compliance reasons (https://propakistani. pk/2019/07/09/heres-why-meezan-bank-is-blocking-payments-to-netflix/).

Bibliography Abdullah, A. A., Sidek, R. and Adnan, A. A. (2012). Perception of non-Muslims customers towards Islamic banks in Malaysia. International Journal of Business and Social Science, 3(11), 151–163.

223

IMAM UDDIN ET AL.

Ahmed, A. (2010). Global financial crisis: an Islamic finance perspective. International Journal of Islamic and Middle Eastern Finance and Management, 3(4), 306–320. Amin, H. (2007). An empirical investigation on consumer acceptance of internet banking in an Islamic Bank. Labuan Bulletin of International Business and Finance, 5, 41–65. Amin, H. (2012). Factors influencing Malaysian bank customers to choose Islamic credit cards empirical evidence from the TRA model. Journal of Islamic Marketing, 4(3), 245–263. Bakhshi, A. M. (2006). Developing a financial model for Islamic credit card for the UK. International Banking & Finance, University of Salford, 1–46. Bilal, M. and Meera, A. K. M. (2015). Al-Muqassah model, an alternative Shari’ah compliant Islamic credit card model for Islamic financial institutions in Malaysia. International Journal of Islamic and Middle Easter Finance and Management, 8, 418–438. Billah, M. M. S. (2003). Islamic credit card in practice. Journal of Islamic Banking and Finance, 25, 35–42. Choo, S. Y., Lim, H. E. and Sanusi, N. A. (2007). The consumer choice of Islamicbased credit card: an analysis of bivariate probit model, in Sanusi, N. A., Harun, M. and Samsudin, S. (Eds), Readings in Islamic Economics and Finance, Universiti Utara Malaysia Press, Sintok, 57–68. Dali, N. R. S. M. and Hamid, H. A. (2007). A study on Islamic creditcards holders. In First National Conference on Islamic Finance (NCiF 2007), Kuala Terengganu. Darwish, A. F. (2003). Can a credit card ever be halal? [Online]. Available: http:// www.baankerme.com/bme/2003/mar/islamic_banking.asp. Ecchabi, A. and Olaniyi, O. N. (2012). Using theory of reasoned action to model the patronization behavior of Islamic bank customers in Malaysia. Research Journal of Business Management, 6, 70–82. Gait, A. and Worthington, A. (2008). An empirical survey of individual consumer, business firm and financial institution attitudes towards Islamic methods of finance. International Journal of Social Economics, 35, 783–808. Hamid, A. and Masood, O. 2011. Selection criteria for Islamic home financing: a case study of Pakistan. Qualitative Research in Financial Markets, 3, 117–130. Hussin, N. (2011). An analysis of attitudes in Islamic and conventional credit cards in Malaysia: perspectives on selection criteria and impact analysis, Durham theses, Durham University. Available at Durham E-Theses Online: http://etheses. dur.ac.uk/3326/. Kazi, M. (2002). Malaysian banks launches first Islamic credit card in Asia. [Online]. Available: http://www.islamonline.net/English/news/2002-07/25/articles06. shtml. Khattak, N. and Rehman, K. (2010). Customer satisfaction and awareness of Islamic banking system in Pakistan. African Journal of Business Management, 4, 662–671. Mansor, N. (2005). Islamic credit card: are demographic factors a good indicator? Prosiding Seminar Ekonomidan Kewangan Islam 2005, University Utara Malaysia, Sinto, Kedah, Malaysia.

224

M U S AW WA M A H C A R D

Mansor, N. and Che-Mat. A. (2009). Islamic credit card: are demographic factors a good indicator. Asian Social Science, 5(12), 17–26. Metawa, S. A. and Almossavi, M. (1998). Banking behavior of Islamic bank customers: perspectives and implications. International Journal of Bank Marketing, 16, 299–313. Mishkin, F. and Eakins, S. (2008). Financial Markets and Institutions, 6th ed., Addison Wesley, New York. Dali, N. R. S. M., Hamid, H. A., Shahimi, S. and Wahid, H. (2008).Factors influencing the Islamic credit cards holder’s satisfaction. The Business Review, 11(2), 298–304. Mokhtar, H. S. A., Abdullah, N. and Alhabshi, S. M. (2008). Efficiency and competition of Islamic banking in Malaysia. Humanomics, 24, 28–48. Noor, A. M. and Azli, R. M. (2009). A review of Shariah compliant instruments for Islamic credit card as adopted by Malaysian financial institution. International Journal of Monetary Economics and Finance, 2(3–4), 221–238. Shayegani, B. and Arani, M. A. (2012). A study on the instability of banking sector in Iran economy. Australian Journal of Basic and Applied Sciences, 6, 213–221. Thambiah, S., Ismail, H. and Eze, U. C. (2011). Customer awareness and current usage of Islamic retail banking products and services in Malaysia. Australian Journal of Basic and Applied Sciences, 5, 667–671.

225

15 THE SOCIO-ECONOMIC IMPACT OF WAQF IN ISLAM A study of the Zakat and Endowment Commission in Sokoto state, Nigeria Muhammad Dahiru Shuni 15.1 Introduction Islam, as a total way of life, covers all aspects of human lives, be it the religious, social, political, or economic spheres. The institution of waqf shows the concern Islam has on the economic and social life of humanity. The philosophical ideologies of Islam behind this institution are many. However, the fundamental ones relate to meeting the basic demand of ummah socially and economically. It further aimed at assisting in boosting the economy of the area and to also foster love and affection among the Muslim brotherhood as it was instituted on the spirit of faith, compassion, humanity, and social responsibility. Although there is neglect among or in many Muslim countries/states about this financial institution, recently some Muslim states in Nigeria have awakened from their slumber and started to revive and encourage the institution through funding and sensitization. Sokoto state is among the states that revived the waqf institution through the establishment of Zakat and Endowment (Waqf) Commission by the government in Nigeria.

15.2 Definition of the concept of waqf Literally, ‘waqf’ as an Arabic word has its root from ‘awqafa’, which means to hold still, to detain, to confine, and not to let go. Technically, waqf, refers to a trust or an endowment that is removed from a private property and dedicated permanently to awqaf properties. Waqf is being kept in perpetuity and for a specific purpose. However, the purpose must be for rendering services to the ummah such as managing healthcare and education, building mosques, and digging wells, boreholes, etc. Waqf, when dedicated and declared by the owner cannot be sold or given out as a gift or be inherited. The definition also covers some newly created forms of awqaf that were not known before in the classical fiqh literature, such as the waqf of financial 226

DOI: 10.4324/9781003050209-15

S O C I O - E C O N O M I C I M PA C T O F WA Q F

rights and the waqf of usufruct. Furthermore, under the above definition, the inclusion of all kinds of assets for waqf is also possible. Hence, waqf is not necessarily in the form of fixed assets such as land or building, but could also be in the form of liquid assets such as cash or shares. Other prominent scholars have also explained the meaning of waqf for instance, Ahmad considers waqf as one of the sources of the Islamic economic system, and defined it as voluntary charity that has a unique presence in Islam. He explained that Islamic law is the first law that had ever defined and regulated waqf as a civil societal institution. He further elucidated that the micro credit and safety net programme were not successful in reducing poverty and income inequality, hence, waqf is seen as one of the vital alternatives. This, according to him, is because of the historical achievements of the waqf institution in the area of education, health, social welfare, etc. In the same way, Yelwa considers waqf as one of the mechanisms of the Islamic economic system capable of changing contemporary human societies from economic dependency to its independence and from poverty to good health. 15.2.1 Waqf in the Qur’an and Sunnah of the prophet (Peace be Upon Him) Waqf draws its legality from the Glorious Qur’an, the Sunnah of the Prophet PBUH as well as the Consensus of both the Companions and renowned Islamic scholars. In the Qur’an for instance, Allah says in Quran that “You will not attain righteousness until you spend from what you love. He further says: “O ye who believe! Spend of the good things which We have provided you with and from what we brought out of the earth for you”. In the same vein, the traditions of the Prophet PBUH have also show the legality of this financial institution. There is Hadith reported by Abu Hurairah who narrated that the Prophet had said that “When the son of Adam dies, his deeds cease except for three: (i) an on-going charity, (ii) a beneficial knowledge and (iii) a righteous son who prays for Him.” In addition, there is another hadith reported by Abu Hurairah that supports the legitimacy of waqf in Islam. According to the hadith, Umar bn Khattab was sent to collect zakat charity and when he came back, he complained to the Prophet that Ibn Jamil, Khalid, and Abbas refused to give out their zakat as some individuals refused him zakat. The Prophet replied that for Khalid: “He reserved (as waqf ) weapons, horse and other war equipment’s”. 15.2.2 Islamic rulings on waqf Waqf is one of the recommendable charities (mustahab). According to Imam Timidhi, he did not know any conflicting view among the companions 227

M uhammad D ahiru S huni

concerning the legality of waqf. Jabir Ibn Abd Allah affirmed that there was no single companion of the Prophet who had the means of waqf and refused to dedicate certain property for the purpose. According to Islamic jurists, there are some fundamental principles of waqf administration. In their opinion, waqf should be administered in accordance with the wishes and aspirations of the endower except if the condition(s) stipulated are against the shari’ah. In case the endower does not specify any condition(s), then the beneficiaries are to be treated equally. The waqf property should be looked after by a specific person(s) designated by the endower, but if he dies, it should be looked after by the person(s) to whom the waqf was dedicated. However, if the waqf was not designed to benefit a certain class of people or places such as the mosque or the Islamiyyah School, then in this situation, the leader of the faith (sultan or imam) or his representative (wakil) should take care of the waqf. Similarly, waqf property designed for one’s family should be shared equally between both males and female. Furthermore, waqf is one of the contracts that is binding on the endower; hence, it is not, according to the popular view, allowed for him to annul it. On the conditions of waqf, some Muslim jurists mentioned the following: 1 2 3 4 5 6

Absolute ownership and authority to dispose it as waqf Waqf item should be one that flourishes. That is to say, its original essence remains while its benefit is always being driven from it. There must be a specification of item/property dedicated as waqf. Unidentified property cannot be considered or accepted as a valid waqf. There must be sincerity in dedicating any property as waqf for good purposes. The property must be in possession of the person intending to set a waqf. It is not allowed to give out waqf property as a charity, inheritance, or sale, However, to Abu Hanifah, waqf can be sold out when the need arises. 15.2.3 Divisions of waqf

Although waqf was not categorized during the time of the Prophet (PBUH), scholars of subsequent generation have categorized it. According to them, waqf is broadly divided into three. Religious waqf (waqf lillah): This type of waqf helps in satisfying some religious needs of the people and reduces the direct cost of providing religious services for any future generations. Philanthropic waqf (waqf al-khayri): It is the waqf that supports the indigent segment of the society and some activities that are of great interest to the community. Family waqf (waqf al-ahli): in this type of waqf, the endower (waqif) puts forth a condition that part of the waqf property be designed or set aside to one’s family and the remaining be given to the poor and needy. 228

S O C I O - E C O N O M I C I M PA C T O F WA Q F

In addition to the above categorizations, waqf can also be categorized in terms of the type of assets involved, such as immovable waqf like land, buildings, movable waqf, such as machinery, equipment, animals, etc., shared waqf, the share of real estate or stocks or shares in investment funds, cash waqf even though the opinions of scholars differ concerning the permissibility of cash waqf because the original does not stay the same, but the Maliki school allows it in formats suitable for the use of permanent value. There is also temporary waqf. 15.2.4 Waqf in historical perspective The wisdom of waqf as an institution is as old as mankind. Although some Muslim jurists opined that the first waqf ever, was the House of Allah (Ka’abah) in Makkah, which is the first ever place dedicated for the worship of almighty Allah. But according to the general or popular opinion of Muslim scholars, there was no waqf in Arabia before the advent of Islam, either in the form of buildings or lands. On the basis of this view, the Muslim jurists traced the institution of waqf to the time of the Prophet (PBUH) as a means of getting a reward and assisting the less privileged in society. Although the Qur’an does not directly define waqf or make any particular reference to it, it encourages Muslims to give charity since Allah has promised multiple rewards for those who generously spend their wealth in a good/ righteous way. Since the emergence of Islam, many Muslims have given out their wealth for the benefit of others in the form of waqf. The Prophet on the other hand, established the first waqf when the “Masjid Quba” and “Al-Masjid Al-Nabawi” in Madinah were built. This was followed by the waqf of seven orchards given to him by mukhairiq to be an on-going charity for Muslims. When the Prophet (PBUH) built his mosque in Madinah, it served as a centre for all religious and temporal issues. It served as a place where the Prophet taught and encouraged the companions on righteous deeds; the waqf was among the deeds of the Prophet that inspired the sahabahs. Umar bn Khattab was one of the sahabahs who was inspired and donated his beloved farm at Khaybar as waqf. Other early awqaf were those during the caliphate of the rightly guided caliphs. The waqf of Uthman bin Affan of Roma well in Madinah, the waqf of Ali bn Abi Talib of a land in Yanbu’a all these served as examples of waqf in the early days of Islam. Thereafter, many different forms of awqaf were introduced for social purposes such as public usefulness, education and research, health care, etc. in different parts of the Muslim world at different times. 15.2.5 Zakat and Endowment Commission Sokoto state Sokoto state is located between longitude 11′30 to 13′50 east and latitude 4′0 to 6′0 north. It is bordered by Niger Republic to the north, Zamfara state to 229

M uhammad D ahiru S huni

the east, and Kebbi state to the south and west. According to the 2011 population figures, the state has projected a population of 4,292,416. The Commission that was established by the Sokoto state and the Government of Nigeria as the ‘Sadaqah’ committee in 1988 was later renamed as a non-profitable Zakat and Endowment Committee in 2007 and is now known as Sokoto State Zakat and Endowment (Awqaf) Commission. The activities of the commission include collection, management, and distribution of zakat and waqf in the areas of shelter provision, rehabilitation of psychiatric patients, training and assistance for the new converts to Islam, welfare packages and training for orphans, the disabled, and the needy, among others. The commission functions under different sub-committees that are saddled with different responsibilities. These sub-committees are responsible for the health, shelter, and welfare of mentally challenged persons, human resources, development, food assistance, orphans, secretariat and special needs, investment, and finally, publicity and enlightenment. Some of these sub-committees are financially supported by the Sokoto state government with substantial amount of money as waqf while other committees rely on voluntary donation by individuals. The commission serves 85 districts across 23 local governments areas in the state. 15.2.6 Waqf properties Waqf, as an aspect that formed the commission, is being headed by the director of the commission. His office manages and administers all the ‘awqaf’ collected by the commission. As was stated earlier, a substantial amount of money is being dedicated to the commission by the state government as waqf funds. There are other individuals and organizations/companies that set some properties as waqf to the commission. For instance, in 2015, First Bank of Nigeria Holding Company donated a 2.5 million cheque as waqf fund to the commission. At the same time, Aliyu Magatakarda Wamakko (former state governor) donated 2 vehicles and 130 sewing machines as waqf to the commission. Other properties received by the commission as waqf include Islamiyyah schools, plots, buses, motorcycles, machines, farmlands, mosques, graveyards, guest houses, libraries, books, and funds. 15.2.7 Beneficiaries The properties collected as awqaf are being used for many purposes aimed at providing succor to the less privileged and the vulnerable in society and improve their standard of living. The waqf shops are being given to those in need of shops for businesses; farms are allotted to those who want to engage in farming activities. Clothes and food items are distributed to those in need, and for those who want to start businesses, financial assistance is 230

S O C I O - E C O N O M I C I M PA C T O F WA Q F

given. Similarly, awqaf fund is being used for the renovation of houses and construction of new ones as well as assistance to poor couples, assistance to the victims of fire incidences, payment of rents, and settling debt. Furthermore, waqf resources are being used to settle medical bills of the poor people who cannot afford to buy prescribed drugs, and psychiatric patients are taken to psychiatric hospitals in the state. 15.2.8 Impact of waqf on the people of Sokoto state Waqf has significantly impacted on the lives of people of the state socially and economically. It will be difficult to determine the impact of waqf on the people of the state, but still, some few areas can be specified using the following typical examples. Waqf money (N6,500 equivalent to 20 USD) is paid as allowance to disabled persons monthly, which has drastically curtailed the number of disabled beggars on the streets of the state. Some of the beneficiaries have become self-reliant by investing the little amount they receive into businesses. Through waqf, medical bills of many psychiatric patients were settled and rehabilitated. Those who suffer from one sickness or the other are given medical treatment and were provided drugs and financially assisted with surgical operations all from waqf funds and have now recovered and are enjoying good health. Similarly, the waqf funds have made an impact on the people of the state who were inflicted with some calamities such as flood, fire outbreak, etc. Many of the affected persons have benefited from a substantial amount of money (depending on the level of the disaster), which has helped some to fully recover from the loss they had incurred. All the more so, waqf structures, such as Islamiyyah schools, masajid, and houses are impacting positively on the beneficiaries of these structures. For instance, lessons are being taught at Islamiyyah schools that make a tremendous impact on students (educationally and morally) and the society as a whole. Waqf houses were allocated to some homeless persons to provide them with shelter. Waqf shops that were allotted to some individuals to run businesses have impacted on their lives socially and economically, and at the same time, they have boosted economic activities in the state. The beneficiaries have become self-reliant and sometimes employers of labour become security to the state by preventing the recruitment of the idle into some activities that are injurious to the social and economic security of the state. 15.2.9 Challenges 1

There is lack of positive response from the business community as waqf is often viewed as a government programme. Many people are reluctant to donate their awqaf. 231

M uhammad D ahiru S huni

2

3 4

5

Although only a small amount and a few properties are collected by the commission as waqf, the demand for the services of the waqf department committee is higher, especially from orphans and needy people, requesting the settlement of medical bills and providing shelter and rehabilitation for the homeless. Some people also hold a negative attitude towards the commission, resulting in viewing it as a politically motivated organization. There is also the problem from Islamic scholars who are supposed to be key actors in sensitizing the ummah on the benefit of waqf; they instead condemn its administration purposely because of their non-inclusion in the administration of the commission. At an individual level, many people do not assist the commission in the discharge of its responsibility; they do not also give their properties as waqf on the basis of their notion that it is the sole responsibility of the government that instituted the commission.

15.3 Recommendation The institution of waqf is very important as it has significantly impacted on the socio-economic lives of the Muslim ummah in Sokoto state (see for example, Sanyinna and Osman, 2017). This is evident in many spheres, such as health, education, and economy. On this basis, the chapter commends the Sokoto state government for reviving this important financial institution and recommends the full involvement of wealthy Muslim ummah of the state in the activities of the commission and specifically waqf institution in ensuring the sustainability of the activities of the commission. Their involvement has no doubt contributed immensely to reducing the rate of unemployment and poverty among the many poor people in the state, and has equally contributed to the general enhancement of their living standards.

15.4 Conclusion Waqf as institution in Islam is a very vital economic tool that if implemented properly will definitely alleviate the economic crisis among the Muslim ummah, and in addition, it has significantly reduced a lot of burden on governments. It contributes in no small measure to solving many of the socio-economic problems of the Muslim ummah and bettering their lives. Should ‘waqf’ attract the attention it deserves, it will no doubt contribute greatly to improving the living standard of people and significantly relieve them of economic adversity. If wealthy people in the state continue to neglect waqf, there would be a repercussion, the less privileged may become parasites and miscreants, involving in social vices and crimes. They can also become potential recruits of violent extremist groups, which will in turn deny wealthy people a comfortable enjoyment of their wealth. Finally, if 232

S O C I O - E C O N O M I C I M PA C T O F WA Q F

we really want to assist the needy and less privileged people among us and alleviate their economic hardship, we must strive hard in reviving and encouraging the institution of waqf.

Bibliography Ahmad, Habib (2004). Integrating Waqf and Islamic Finance, Power Point Presentation, Durham University Amir San’ani. (1999). Al’uddah Al-Ikhkam al-Ihkam Sharh Umdah al-Ahkam. Beirut: Dar al-Kotob al-Ilmiyyah, Vol. 4. Boudjellal, M. (1999). The Need for a New Approach of the Socio-economic Developing Role of Waqf in the 21st Century, Power Point Presentation. Çizakça, Murat (1998). “Awqaf in History and Its Implications for Modern Islamic Economies”, in Islamic Economic Studies, vol. 6, no. 1, 28 Dafterdar, H., & Bank, U. I. (2009). Towards Effective Legal Regulations and Enabling Environment for Awqaf. In International Conference on Waqf Laws & Management. Kahf, M. (2003) The Role of Waqf in Improving the Ummah Welfare. In International Seminar on Waqf as a Private Legal Body (pp. 6–7). Khan, M. M. (2016). The Glorious Qur’an. Riyad: Darus-Salam Publication. Sanyinna, A. Y., & Osman, M. F. (2017). Analytical Overview of the Role Played by Waqf in Poverty Alleviation: A Case Study of Sokoto State, Nigeria. Asian Journal of Multidisciplinary Studies, 5, 18–30. Mohammad, M. T. S. H., Iman, A. H. M., & Omar, I. (2006). An ideal financial mechanism for the development of the Waqf properties in Malaysia. Johor Bahru: Universiti Teknologi Malaysia. Muslim bn Hajjaj (2010) Sahih al-Muslim. Beruit: Dar Ihya’ al-Turath al-Arabi. Qureshi, Anwar Iqbal (1967) Fiscal System of Islam. Lahore, Pakistan: Institute of Islamic Culture. Printed by Zahid Iqbal Printing Press, , pp. 186–187. Sabiq, A. S. (1999). Fiqh al-Sunnah, j. 1, c. 2. Kaherah: Dar al-Fath Lil‟ ilam al-„Arabi. Ahmed, H. (2004). The Role of Zakat and Awqaf in Poverty Alleviation, Occasional Paper No. 8, IRTI, Jeddah, Saudi Arabia., Islamic Development Bank. Toraman, C., Tuncsiper, B. and Yilmaz, S. (n.d.) Cash Awqaf in the Ottomans as Philanthropic Foundations and their Accounting Practices. Turkey: Faculty of Economics and Administrative Sciences Business Administration, Accounting and Finance Balikesir-University. Yelwa, M. I. (2017) “Waqf Endowment Institution”: An Alternative Mechanism for Poverty Alleviation in Nigeria and Its Developing Counterparts. E-Proceeding of the 4th International Conference on Masjid, Zakkat and Waqf Management (IMAF-2017), 4th and 5th December, Bangi, Selangor, Malaysia.

233

16 BUSINESS ZAKAT REPORTING Evidences from the Islamic financial institutions Teh Suhaila Tajuddin and Izlawanie Muhammad 16.1 Introduction Business zakat is imposed on the net wealth of businesses in commodities comprising industrial and consumer products, construction, plantation, and infrastructure. One of the most rapidly growing industries is financial services. The financial services industry in Malaysia is divided into the Islamic financial system and conventional financial system. Complementing the conventional system, the Islamic financial system offers a comprehensive and broad range of Islamic financial products and services, including banking system, money market, takaful, and capital market. As the Islamic financial system has evolved into a viable and vibrant component of the overall financial system, Islamic financial institutions (IFIs) are the important market players in meeting the changing requirements of the new economy (Tatiana et al., 2015). In assessing the performance and position of the IFIs, financial reporting is significantly important to be referred to by various stakeholders. IFIs are required under the Financial Services Act 2013 (FSA) and the Islamic Financial Services Act 2013 (IFSA) to prepare their financial statements in accordance with the Malaysian Financial Reporting Standards (MFRS). Bank Negara Malaysia (BNM) is the central bank of Malaysia which regularly issue a policy document entitled “Financial Reporting for Islamic Banking Institutions” since 2003. The policy document is then being reviewed from time to time for BNM to take into consideration the current needs and changes. Recently, the updated version of the policy document on “Financial Reporting for Islamic Banking Institutions” has been issued by BNM on 2 February 2018. A policy document aims to ensure adequate disclosures by an IFI in its financial statements to improve comparability for users of financial statements and better facilitate the assessment of an IFI’s financial position, performance, and shari’ah compliance. Thus, IFIs are required to comply with the requirements in the policy document in the preparation and publication of its separate financial statements and 234

DOI: 10.4324/9781003050209-16

BUSI N E S S Z A K AT R E P ORT I NG

consolidated financial statements. Specifically, an IFI shall disclose the recognition and measurement accounting policies on IFI’s obligation on zakat, which may alternatively be disclosed under the director’s report. An IFI that does not pay zakat must also disclose a statement to that effect in the financial statements. An IFI that pays zakat shall disclose additional information regarding: (i) its responsibility towards zakat payment either on the business, and/or behalf of the shareholders; (ii) method applied in the determination of zakat base, e.g. growth method, working capital method; and (iii) the beneficiaries of the fund, e.g. Baitul Mal, for the poor and the needy. Apart from the document policy on IFI’s zakat reporting, the Shari’ah Governance Framework was introduced in 2011 by BNM to strengthen the regulatory framework and governance practices for the IFIs. Within the framework, the Shari’ah Advisory Board or Committee plays an important role in monitoring the compliance of Islamic banking activities with the shari’ah requirements including zakat. With respect to the zakat obligations disclosure, IFIs are required to disclose their responsibility towards payment of zakat on behalf of the business, shareholders, or depositors. The obligation of zakat on the business is derived from several evidences from al-Qur’an, al-hadiths, al-ijmak ulama, and al-qiyas. The most prominent verse regarding zakat on business is as follows: Allah S.W.T says, O you who believe! Spend of the good things which you have earned, and of that which We have produced from the earth for you and do not aim at that which is bad to spend from it, (though) you would not accept it save if you close your eyes and tolerate therein. And know that Allah is Rich (Free of all wants), and Worthy of all praise. al-Baqarah:267 According to Al-Tabari (2000), “spend of the good things which you have earned” refers to economic activities such as the business sector. Thus, business entities are obligated to perform zakat on what they have put on their efforts in generating income and profit. At the same time, the business entities have to ensure the business assets must be from halal sources and all the business activities too must come from halal activities or services. Imam al Ja’ssas and Imam Abu Bakr ibn al ‘Arabi have been reported to assert the same opinion that zakat is obligatory on trading activities (Al-Qaradawi, 2000: 204). Hadith from Rasulullah, s.a.w., as narrated by Abu Dawud reported from Samurah ibn Jundub,that, The Prophet (s.a.w.) used to order us to pay the sadaqah (zakat) on what we have prepared for trade (urud al-tijarah).(Abu Dawud, 1557) 235

T eh S uhaila T ajuddin and I zlawanie M uhammad

The above hadith clearly stated that zakat is obligatory on goods or inventories that are ready to be sold. The Prophet, s.a.w., gave an order to perform zakat on a business inventory. Many jurists refer to the business inventory as urud al-tijarah, which means any commodities obtained for the purpose of resale for profit (Abu Bakar, Ibrahim & Md Noh, 2014). However, some jurists define urud al-tijarah differently and it has contributed to various business zakat accounting methods used by business entities (Zahri, 2014). The Shari’ah Advisory Board or Committee plays significant roles not only to ensure IFIs comply with shari’ah requirements but also to confirm that payment of zakat is reported accurately. Reporting on business zakat must include information on the recognition of zakat, measurement of assets and liabilities for zakat, and presentation and disclosure of zakat in the financial report (Noor et al., 2011). However, the reporting standards on business zakat accounting between IFIs are not consistent because the banking and finance institutions in Malaysia are not compulsory to comply with the Technical Release i-1: Accounting for Zakat on Business issued by Malaysian Accounting Standard Board (MASB) and Accounting and Auditing of Islamic Financial Institutions (AAOIFI) and Financial Accounting Standard 9 FAS 9) on zakat. Thus, there is disparity in the treatment of zakat reporting among entities that pay zakat as no accounting pronouncement issued by the International Accounting Standard Board (IASB), MASB and the IFIs are guided by the Shari’ah Governance Framework. Researchers have given less attention on this issue; thus, little is known about businesses’ zakat reporting, particularly by the IFIs. The aim of this chapter is to critically analyse business zakat reporting of IFIs in Malaysia and to provide recommendations for improvements. Similarities and differences of zakat reporting of IFIs will be presented and recommendations for a standardised zakat reporting will be given in this study. A qualitative research methodology is adopted in this study; a content analysis technique was adopted by analysing three public-listed IFIs’ business zakat reporting in their annual reports. The analysis was conducted particularly on the recognition of zakat, measurement for assets and liabilities for zakat, and presentation and disclosure of zakat on business. At the end of this study, suggestions to improve a standardised zakat reporting to provide a comparable and reliable financial information of IFIs are discussed. 16.1.1 Business zakat reporting for IFIs The need for a sound accounting and reporting system for IFIs has been called since 1990s as to meet the shari’ah requirements and to fulfil stakeholders’ demand for transparency (Abdul Rahman, 2003; Noor et al., 2011). In Malaysia, the Shari’ah Governance Framework has outlined the requirements for IFIs with respect to the state of compliance with shari’ah 236

BUSI N E S S Z A K AT R E P ORT I NG

principles. An IFI shall disclose the Shari’ah Committee’s report as part of the annual report and signed by not less than two members of the committee. With regard to business zakat assessment on IFIs, the Shari’ah Committee’s report shall contain zakat computation on the face of IFI’s financial statements. One of the main financial reporting disclosures aimed at zakat obligation discharging by IFIs (Abdul Rahman, 2003). However, research has consistently shown that there is a low compliance of zakat disclosures among shari’ah-compliant companies including IFIs. The information disclosed is very limited and some of the explanatory notes are absent. If the business has fulfilled their zakat obligation, then they should disclose the related zakat information on their annual report and thus enhance the transparency level in shari’ah-compliant companies (Noor et al., 2011). IFIs should also furnish additional information for stakeholders as to be properly informed of their rights and obligations on zakat and to promote greater transparency. The requirement for an accounting standard for zakat becomes the main concern nowadays. The MFRS that serve as a basis for financial reporting in Malaysia have been fully converged with the International Financial Reporting Standards (IFRS) since 2012(BNM, 2016). Ongoing improvements of these standards have contributed to a greater alignment between financial reporting and prudential frameworks. As far as business zakat reporting is concerned, no separate Islamic accounting standard is needed, instead the option needs to be within the IFRS framework with the collaboration work of AAOIFI and the IASB (Mohammed et al., 2015). The convergence between Islamic and conventional accounting will produce complete and transparent financial reporting. A previous study stated that harmonisation between zakat assessment and zakat accounting is highly needed (Abdullah Ibrahim et al., 2012; Mohammed et al., 2015). It can be concluded that the integration between zakat assessment and zakat accounting is very crucial. Technical Release i-1: Accounting for Zakat on Business issued by MASB. In 2006, MASB issued a technical release i-1 that deals only with financial reporting issues related to zakat on business. It sets out the overall considerations and provides guidance on the application of generally accepted accounting principles to the recognition, measurement, presentation, and disclosure for zakat on business in the financial statements . This technical release is applicable to zakat-paying entities including IFIs. Since there is no accounting pronouncement issued by the IASB yet, the technical release by AAOIFI entitled Financial Accounting Standard 9 (hereafter FAS 9) on zakat is often used by IFIs as the main base of reference. In addition, the technical release spells out that an entity shall refer to the relevant State Islamic Religious Council or its relevant zakat authorities for any issues relating to zakat on business such as zakat chargeability of an entity, calculation of zakat, determination of zakat base, and zakat eligibility of assets and liabilities. 237

T eh S uhaila T ajuddin and I zlawanie M uhammad

16.1.2 Recognition Para 3 of the Tri-1 stated that zakat for the current period shall be recognised when an entity has a current zakat obligation based on zakat assessment and an outflow of resources embodying economic benefits. When an entity pays zakat on its business assets, such amount of zakat is recognised as an expense and included in the statements of profit or loss and other comprehensive income when it is incurred. Recognition of assets and liabilities is another important step before zakat is calculated. 16.1.3 Measurement Measurement of assets and liabilities are made on the date zakat is assessed. An entity shall measure zakat assets and liabilities on the same measurement basis as used in the preparation of its financial statements. One of the conditions of business zakat to be fulfilled by an entity is a haul completion. Zakat shall be assessed when the entity has been in operation for at least 12 months. Then, zakat on business shall be calculated by multiplying the zakat rate with the zakat base. In Malaysia, National Fatwa Council has determined that the rate of zakat on business is 2.5% of the zakat base. Zakat base is referring to the net adjusted amount of zakat assets and liabilities used for or derived from business activities. An entity is advised to refer to the relevant zakat authorities for further guidance in determining the net adjusted amount of zakat assets and liabilities. In determining the zakat base, an entity may apply one of the methods recommended by the Malaysian Islamic Development Department (JAKIM) in Panduan Zakat di Malaysia, 2001: (a) adjusted working capital method; or (b) adjusted growth method (see for detail Hamat 2009). The adjusted working capital method calculates zakat base as net current assets, adjusted for items that do not meet the conditions for zakat assets and liabilities. The adjusted growth method calculates zakat base as owners’ equity and long-term liabilities, deducted for property, plant, and equipment and non- current assets, and adjusted for items that do not meet the conditions for zakat assets and liabilities as determined by the relevant zakat authorities. Adjusted working capital model is accepted as most closely complying with shari’ah principles and it has been supported by several jurists (Al- Qaradawi, 2000; Rohila & Mohd Zulkifli, 2012; Zahri, 2014; Ahmed et al., 2016). 16.1.4 Presentation and disclosure In presenting the business zakat discharged by IFIs, para 15 specified that the amount of zakat assessed for the current period shall be presented as a line item on the face of the income statement. For disclosing the zakat obligation, para 16 stated that an entity shall disclose in the notes accompanying 238

BUSI N E S S Z A K AT R E P ORT I NG

the financial statements (a) the method used in the determination of zakat base; (b) its responsibility towards payment of zakat on business; and (c) major components of zakat. Further, para 17 described the components of zakat may include: (a) current zakat expense; (b) zakat payment; (c) zakat liability; and (d) any adjustments recognised in the period for zakat of prior periods. The computation of zakat on business still remains the same as per calculation reported by Abu ‘Ubayd (1991). In modern businesses, adjustments on certain items of business assets and liabilities are needed to calculate the accurate business zakat payable and in compliance with shari’ah principles (see AAOIFI’s and FAS 9 on zakat). The AAOIFI’s FAS 9 sets out accounting rules related to zakat on business issued in 1999 (Adel, 2013). It is a guideline used by IFIs for the accounting treatments related to the determination of the zakat base, measurement of items included in the zakat base, and disclosure of zakat in the financial statements of IFIs. The basis of AAOIFI classification is based on the wellknown shari’ah classification of trade commodities for the purpose of zakat (Abdul Rahman, 2003). With the recent rapid growth of IFIs, there is still an inconclusive stance regarding the need for specified accounting standards for IFIs such as the ones issued by AAOIFI (Mohammed et al., 2015). In Malaysia, although the AAOIFI standard has not been adopted, it has been used as a guideline by many IFIs. The standard proposed two models for zakat assessment namely net current assets method and net invested funds method. Under the net current assets method, the difference between current assets and current liabilities will represent the working capital or net assets of the business. Net invested fund takes into consideration the sources of funds, such as share capital and reserves, non-current liabilities, and are deducted with non-current assets. Almost the same with Tri-1 treatment, AAOIFI’s FAS 9 requires zakat to be treated as a non-operating expense of the IFIs and included as a deduction from net income. This is appropriate to reflect the financial obligation of the entity. If the zakat is unpaid, it will be treated as a liability of IFIs. In computing the zakat base, the basic equation is to be applied to assess zakat on IFIs and other types of businesses. As for uncollected debts from customers, they are not zakatable unless they are paid back. Then, they must be zakated once only, on the basis of the similarity with earned wealth that is zakated at the time it is acquired. It is obvious that liabilities are deducted from assets and only the net is zakatable. When business zakat is computed, the assets, liabilities, and equity of the business need to be analysed to classify whether they are subject to zakat or not. The adjustment on certain business assets and liabilities are needed to arrive at an accurate zakat payable amount (Table 16.1). Previously, zakat authorities were found to be using several approaches for calculating zakat on business. Nonetheless, productive and successful 239

T eh S uhaila T ajuddin and I zlawanie M uhammad

Table 16.1 Principal Activities and Statement on Zakat Obligation by Different IFIs Institution Principal Activities IFI 1

IFI 2

IFI 3

Statement on Zakat Obligation

Zakat represents business zakat The company is principally payable by the company to comply engaged in all aspects of with the principles of shari’ah Islamic banking business and as approved by the Shariah and related financial Advisory Council (SAC). The bank services in accordance with only pays zakat units business and sharibah principles. The does not pay zakat on behalf of bank is a licensed Islamic depositors or shareholders. Zakat Bank under the Islamic provision is initially calculated Financial Service Act 2013 based on 2.5% of the growth (IFSA), incorporated and model method. However, it will domiciled in Malaysia. be compared against 2.5% of the bank’s audited profit before tax (PBT) for the year, and the higher of the two will be the final zakat for the bank. The bank paid the zakat on the The bank is principally bank’s portion, i.e., shareholders’ engaged in Islamic banking fund as well as other funds business and the provision received by the bank except for of related services. depositors’ fund. Several zakat The bank fulfilled its authorities have mandated the obligation to pay zakat on distribution of a portion of its business to state zakat the zakat paid by the bank on the authorities by adopting basis of the bank acting as their the capital growth agent (wakil) for distribution to computation method eligible beneficiaries (asnaf ) among and in compliance with needy individuals, mosques, the Manual Pengurusan non-governmental organisations, Zakat Perbankan issued by institutions of higher learning Jabatan Wakaf, Zakat dan (needy students welfare funds), and Haji (JAWHAR). schools as guided by the Business Zakat Payment Guideline. Zakat represents tithes payable The company is principally by the company to comply with engaged in managing the principles of shari’ah and family and general as approved by the Shariah takaful businesses. It is Advisory Board (SAB). The zakat a public limited liability computation is reviewed by the company, incorporated SAB. The board has the discretion and domiciled in Malaysia to pay additional zakat above the and is listed on the Main obligatory amount payable. Market of Bursa Malaysia Zakat is computed at 2.55% of zakat Securities Berhad. base of the company, which is computed using the adjusted growth method, as approved by the SAB.

240

BUSI N E S S Z A K AT R E P ORT I NG

efforts have been made by the authorities to streamline and fine-tune these approaches. The original text on business zakat assessment only instructs for zakat payment based on inventories or goods for sale. This refined approach has been published by JAKIM and adopted by almost all the state zakat authorities. There are two types of methods for zakat on business, i.e. ‘urfiyyah method and shar’iyyah method (Hamat, 2009). Nevertheless, the most popular method for zakat computation of zakat on business is the shar’iyyah that considers current assets, deduction of current liabilities, and necessary adjustments at year-end. Both the methods are derived from the statement of financial position (balance sheet) with the resulting answer being the same. Thus, both models will need adjustments of the same nature. The computation of zakat on business still remains the same as per calculation reported by Abu ‘Ubayd (1991). In today’s modern businesses, adjustments on certain items of a business’s assets and liabilities are needed to calculate the accurate amount of business zakat payable and to ensure compliance with shari’ah principles. However, the recognition on current assets that are subject to zakat and recognition on current liabilities that are not subject to zakat is not uniform among business entities (Zahri, 2014). Thus, it leads to different treatment on current assets and current liabilities that are subject to zakat. Consequently, the business zakat computation will be misleading and inaccurate. It is suggested that discussions among practitioners and zakat amil should be conducted to achieve a consensus on the analysis and treatment of current assets and current liabilities. 16.1.5 Case studies on three Islamic financial institutions This study aims to explore business zakat reporting among IFIs in Malaysia. A qualitative research approach is adopted in this study by comparing three public-listed IFIs business zakat reporting. These IFIs were selected due to the availability of zakat information on their annual reports. Content analysis on the annual reports of the IFIs was conducted to identify the recognition, measurement, presentation and disclosure for zakat on business in the financial statements. Analysis covers annual report for the years ended 2016 and 2017 on the selected IFIs. 16.1.6 Recognition on zakat expenses In terms of recognising zakat expenses, all three IFIs have presented zakat expenses on the statements of profit or loss and other comprehensive income for the years ended 2016 and 2017. After profit before zakat and tax are determined, the entity recognises the current zakat expense. 241

T eh S uhaila T ajuddin and I zlawanie M uhammad

16.1.7 Measurement of assets and liabilities for zakat It is found that IFIs not only measured assets and liabilities for zakat, but some IFI measures fund equity when they use a different formula. The process of measuring assets, liabilities, and equity needs to be properly adjusted either subject to zakat or not. Besides that, a consideration on shari’ah requirements should be given for true and fair value assets, liabilities, and equity for zakat computation purposes (Abdul Rahman, 2010). 16.1.8 Presentation and disclosure of zakat The amount of zakat assessed for the current period shall be presented as a line item, which is zakat expense, on the face of the statements of profit or loss and other comprehensive income. With reference to the disclosure requirement of zakat on business under para 16, IFIs shall disclose in the notes accompanying the financial statements the (a) method used in the determination of zakat base; (b) its responsibility towards payment of zakat on business; and (c) major components of zakat. As stipulated under para 17, components of zakat may include (i) current zakat expense; (ii) zakat payment; (iii) zakat liability; and (iv) any adjustments recognised in the period for the zakat of prior periods (Table 16.2). Based on Table 16.1, all of the IFIs used different methods in the determination of the zakat base. Only IFI 3 adopted a method as recommended by JAKIM, which is the adjusted growth method. That method calculated the zakat base as net current assets and include adjusted for items that do not meet the conditions for zakat assets and liabilities. IFI 1 seems to be consistent with the method for computing zakat on business recommended by AAOIFI, which is net invested funds. IFI 2 is using a method, which is not suggested by either MASB and/or AAOIFI. It shows that IFIs adopt the zakat computation method that suits their nature of businesses. By comparing the disclosure of the zakat method over 2016 and 2017, it is found that the methods used for the determination of the zakat base have been applied consistently from one period to another by the three IFIs. In terms of disclosure of the IFIs’ responsibilities towards payment of zakat on business, they have disclosed it under the Shariah Advisory Committee report. IFI 2 disclosed that during the financial year, the IFI fulfilled its obligation to pay zakat on its business to state zakat authorities. The IFI paid the zakat on the bank’s portion i.e. shareholders’ fund as well as other funds received by the IFI except for depositors’ fund. Furthermore, IFI 2 disclosed more details on distributions of zakat to the beneficiaries (asnaf). Several zakat authorities have mandated distribution of a portion of the zakat paid by the institution on the basis of the institution acting as their agent (wakil) for distribution to eligible beneficiaries among needy individuals, mosques, non-governmental organisations, institutions of higher 242

BUSI N E S S Z A K AT R E P ORT I NG

Table 16.2 Disclosure of Zakat Items Analysis

IFI 1

a Method used in the Shareholders’ determination of funds growth zakat base method b Its responsibility Zakat obligations towards payment presented under of zakat on disclosure of business the Shariah Committee c Major components Presented as a of zakat line item on i Current zakat the statements expense of profit or loss and other comprehensive income ii Zakat payment Disclosed on the statements of cash flows as zakat paid iii Zakat liability Presented on the consolidated statement of financial position as provision for zakat and taxation iv Any adjustments No disclosure recognised in the period for zakat of prior periods.

IFI 2

IFI 3

Capital growth computation method Disclosure under the report of the Shariah Supervisory Council Presented as a line item on the statements of profit or loss and other comprehensive income Disclosed on the statements of cash flows as zakat paid Presented on the consolidated statement of financial position as provision for zakat and taxation No disclosure

Adjusted growth method Disclosure under the Shariah Advisory Body’s report Presented as a line item on the statements of profit or loss and other comprehensive income Disclosed on the statements of cash flows as zakat paid No disclosure

No disclosure

Sources: Annual Report 2016 and 2017 of IFI 1, 2 and 3.

learning (for students’ welfare funds), and schools. In addition, IFIs have stated that the calculation of zakat is in compliance with shari’ah principles. Major components of zakat disclosures are zakat expense, zakat payment, and zakat liability. Both IFI 1 and IFI 2 have fully presented all components except for IFI 3, which does not disclose the provision for zakat liability in the statement of financial position. It means that IFI 3 does not provide provision for zakat liability after the completion of a haul. The outcomes of this study highlight the similarities, differences, and current state of business zakat reporting of the IFIs. Thus, this study provides suggestions for a business zakat reporting standard to provide comparable and reliable financial information to the IFIs. It also promotes transparency and completeness of business zakat assessments for the stakeholders. 243

T eh S uhaila T ajuddin and I zlawanie M uhammad

16.2 Conclusion The trend of business zakat reporting among the IFIs has been increasing but the need for a proper accounting standard is in quest. The promulgation of accounting standard is vital to encourage IFIs and other Islamic business entities to discharge their zakat obligation. Zakat reporting is not only for the stakeholders, instead it is the role of the IFIs for fulfilling their social responsibility. At the same time, by providing proper zakat reporting, it would encourage IFIs in promoting a sustainable business environment. This study found that different assessment methods for business zakat are necessary to fit with their own businesses’ characteristics. As far as IFIs are concerned, the computation method adopted for business zakat is dissimilar even though the businesses are in the same sector. The choice of different business zakat methods might be influenced by the size of the business (small or medium), sectors of business (manufacturing or services), and types of business entities (sole-proprietorship, partnership, or company). The use of different methods in computing business zakat should also be adopted as to ensure the zakat computed is in line with the shari’ah principles and to avoid zakat being ignored. It is high time accounting standards for zakat on business were developed and practiced by businesses, especially IFIs. For IFIs to perform the role effectively, accounting standards must be complied with by IFIs (Abdul Rahman, 2010). By depending on the technical release on accounting for zakat on business zakat, which was released in 2006, the guideline seems to be outdated and irrelevant to be applied by various types of business entities. With the rapid growth of IFIs locally and internationally, the convergence between shari’ah principles and accounting is proved to be useful in developing objective, transparent, and complete accounting standards for zakat on business. In addition, accounting standards would improve the quality of zakat reporting disclosure in the financial statements and improve the comparability of the reported financial information on the zakat of the IFIs. By providing a complete and transparent business zakat reporting to the public, more businesses can be encouraged to fulfil their zakat obligations. For future research, it is suggested that face-to-face interviews are conducted among the preparers or officers who are highly involved in preparing the financial statements of IFIs to explore the justifications for the selection of such zakat computation methods. Furthermore, the computation of zakat payable could be further investigated thoroughly from the interview sessions. The main limitation of this study is the focus on the three selected IFIs. Future studies can explore and examine zakat reporting by other IFIs in Malaysia.

References Abdullah Ibrahim, A. A. A., Abdul Kadir, M. R. &, & Syed AdwamWafa, S. M. G. W. (2012). Assessing financial reporting on adopting business zakat guidelines on

244

BUSI N E S S Z A K AT R E P ORT I NG

Malaysian government linked companies. International Journal of Business and Social Science, 3(24), 220–229. doi:10.4135/9781446249215. Abdul Rahman, A. R. (2003). Accounting regulatory issues on investments in Islamic bonds. International Journal of Islamic Financial Services, 4(4). Retrieved from https://pdfs.semanticscholar.org/db9e/d89fe17ea930ea97e13ec7d9c da34d072477.pdf. Abdul Rahman, A. R. (2010). An Introduction to Islamic Accounting Theory and Practice. Kuala Lumpur: CERT Publications. Abu ‘Ubayd al-Qasim. (1991). Kitab al-Amwal, 454, 1185; Tajuddin, T. S., & Nor, F. M. (2018). Business Zakat Reporting of Co-Operatives: Case Studies in Malaysia. In International Conference on Management and Muamalah, 5, 494–499. Adel, M. S. (2013). The move towards global accounting standards for Islamic financial institutions: evidence from AAOIFI. Journal of Islamic Economics, Banking and Finance, 9(4), 154–163. doi:10.12816/0031381. Ahmed, E. R., Aiffin, K. H. B., Alabdullah, T. T. Y., & Zuqebah, A. (2016). Zakat and accounting valuation model. Journal of Reviews on Global Economics, 5, 16– 24. doi:10.6000/1929-7092.2016.05.02. Al-Qaradawi. (2000). Fiqh az-Zakah: A Comparative Study. Kahf, M., Trans. London: Darul-Taqwa Ltd. Al-Tabari, A. J. M. (2000). Abū  Jaʿfar Muḥammad ibn Jarīr ibn Yazid al-Ṭabarī (Waines, David: Al-PERLINK "https://www.b, Encyclopædia Britannica, UK (Is also under Muhammad, Jarir (2000). Tafsir al-Tabari, Muassasah Risalah). Bakar, A. A. A., Ibrahim, M. A., & Noh, S. M. (2014). Zakat management and taxation. Book published by IBFIM, University of Sinse Malaysia, publication. Bank Negara Malaysia. (2016). Financial reporting for Islamic banking institutions. Available at BNM: https://islamicbankers.files.wordpress.com/2013/ 12/20160205-financial-reporting-for-islamic-banking-institutions.pdf. Hamat, Z. (2009, July). Business zakat accounting and taxation in Malaysia. In Conference on Islamic perspectives on management and finance (Vol. 322). MASB. (2006). MASB Technical Release i-1 Accounting for Zakat on Business. Mohammed, N. F., Fahmi, F. M., & Ahmad, A. E. (2015). The influence of AAOIFI accounting standards in reporting Islamic financial institutions in Malaysia. Procedia Economics and Finance, 31, 418–424. doi:10.1016/S2212-5671(15)01216-2. Noor, R. M., Rashid, & Mastuki, N. (2011). Zakat and tax reporting: disclosures practices of Shari’ah compliance companies. In 2011 Colloquium on Humanities, Science and Engineering (pp. 877–882). IEEE. doi:10.1109/CHUSER.2011.6163862. Rohila, A., & Mohd Zulkifli, M. (2012). Comparative analysis of current values and historical cost in business zakat assessment: an evidence from Malaysia. International Journal of Business and Social Science, 3(7), 286–298. Tatiana, N., Igor, K., & Liliya, S. (2015). Principles and instruments of Islamic financial institutions. Procedia Economics and Finance, 24(July), 479–484. doi:10.1016/ S2212-5671(15)00613-9. Zahri, H. (2014). Perakaunan Zakat Perniagaan di Malaysia. Kuala Lumpur: Dewan Bahasa dan Pustaka.

245

17 THE BLUEPRINT OF PRE-HIGHER EDUCATION PROGRAM A platform to uplift the B40 economic position through Islamic social finance Aini Japar, Siti Salwa Salleh, Mazlina Mahdzar and Ahmad Shahril Azwan Abdul Rahim 17.1 Introduction Poverty can be defined as a lack of necessary material resources and it can directly affect children’s overall development. In Malaysia, people are categorized into three different income groups, which are top 20% (T20), middle 40% (M40), and bottom 40% (B40). The B40 group is defined as a group of lowest earners in which the family household income is below RM4,000 per month. In 2017, the poverty line for income households has been set up as RM910 for West Malaysia and RM710 for East Malaysia (ekasih, 2014). With the lowest income, the B40 normally has less access and ability in meeting their family’s needs. Thus, their children are likely to have an inconducive learning environment with fewer books around, difficulties in getting proper daily meals, and possess limited access to the Internet. These will result in fewer exposures to learning and life experiences, lack of general knowledge, and less ability in language development and enrichment (Wadsworth & Rienks, 2012). Based on research, these limitations will hinder much of their cognitive development. In Malaysia, primary and secondary education is free for all citizens. Thus, the B40 managed to send their kids to school. In the final year of the secondary level, all students who are 17 years old will be sitting for the Malaysia Certificate of Education examination. The examination results among the B40 students are varied, a number of them did not fulfill the university’s basic entrance requirements. In practice, the minimum requirement to enter any diploma or matriculation program is five credits. Therefore, some of those who obtained four or three credits may not be able to pursue their dream.

246

DOI: 10.4324/9781003050209-17

UPLIFTING THE B40 ECONOMY

University Technology MARA (UiTM) realized this issue, and as one of the largest universities in Malaysia, UiTM believes that giving students a second chance would be the best approach. On the other hand, UiTM also stands for the principle that education is one of the best components that contribute to human capital development and plays an important role in the economic uplifting agenda. To that end, in 2010, UiTM initiated a corporate social responsibility (CSR) program named “Change Destination of Nation Youth” Program. In May 2019, it was rebranded as the Pre-Higher Education Program. On record, from 2010 until 2018, 40,916 students have been enrolled in the PPT pre-diploma program (hereafter called PPT). To date, there were more than 32,000 students or 89% who successfully pursued their diploma in the social and science and technology streams (Jaapar et al., 2019). At that time, the main objective of the program was to provide equal chances and access to B40 students to pursue their studies at the university through a special entrance channel. In the long run, this will provide them a better opportunity to pursue their studies at diploma, bachelor’s degree, master’s degree, and Ph.D. levels. This will help to improve their family’s economic position when they join the working sectors after graduating. According to News Strait Times (2019), in the past four decades, Malaysia has had an impressive performance as the front-runner in the commercial sector of Islamic finance, and this is an indicator that it will be to lead the revitalization of Islamic social finance. As an evidence, since the past ten years, PPT has implemented the Islamic social finance instrument in reducing poverty and addressing challenging socio-economic development through education. Among Islamic social finance instruments as zakat, sadoqah, and waqf, PPT students have been provided with allowance throughout their six months of study using two of them, which are zakat and sadoqah. These arrangements were made by the Center of Zakat, Sadoqah, and Waqf at UiTM. Apart from the B40, it was also open to two other types of students who are the indigenous pupils (Orang Asli) and athletes. To fit the intention, PPT offers two different tracks: pre-diploma commerce and pre-diploma science. Pre-diploma commerce serves a remedial curriculum to strengthen students’ capabilities in mathematics and English, while pre-diploma in science focuses on science subjects such as physics, chemistry, and biology. To tap a bigger group of potential candidates, the program accepts students aged between 18 and 23 years old. In terms of campus and location, students were allocated nationwide from East to West Malaysia. The headquarters is at the main campus in UiTM Shah Alam, Selangor. Each of the thirteen state campuses runs the program as to cater to the B40 students in their states. Students will be accommodated at the campus closest to their hometown. 247

A I N I JA PA R E T A L .

The CSR program was started small and without any predetermined framework. But over time, it has evolved gradually for ten years and a lot of improvement has been achieved. It is time to formalize the framework, not only to view the mechanism in a clearer form, but also to help UiTM find room for improvement. Thus, to look at how the PPT works, this study examined all of the components involved. Each component has been analyzed and distinguished. Stakeholders and collaborators have been arranged properly and their contributions were identified. Connections of one component to the other have been pipelined. At the end, this study presents the blueprint of the PPT framework. This chapter is arranged in the following structure. It started with the first section, which covers an introduction to the B40, university, and the CSR program. Section 17.2 indicates the aim of this study and is followed by Section 17.3 that presents the literature review of similar studies conducted by other researchers. Next, Section 7.4 discusses the methodology, and it is followed by Section 7.5 that presents the discussion of the framework. Finally, in the last section, we present our concluding remarks and brief about future work.

17.2 Study aims The purpose of this study is to examine, arrange, and draw a blueprint of a framework of the PPT. The blueprint will serve as a guide not only to those who involved and contributed to the process, but also to other organizations, researchers, and interested parties to understand and replicate the implementation, especially those in the developing country. Apart from that, this topic will also open for discussion among researchers and educators who study on the same subject matters. The framework shows the mechanics of the whole structure, and the drawing is vital as it’s build and flow dictate how each component plays its role. The analysis of the blueprint is supported by justification, purpose, and significance. Nevertheless, the blueprint is also one of the indicators to UiTM to view an overall set up of the PPT programs in which this will lead to necessary upgrades or addition for comprehensiveness upon further accomplishment in the future. Apart from that, the blueprint also draws an evidence of sustainable Islamic social finance ecosystem through education.

17.3 Literature review Poverty is linked to lower achievement in academics among the youth of B40 families (Hassan & Rasiah, 2011). They are less likely to excel in academics, compared with students who rose above the poverty threshold. Correlation between poverty and academic achievement shows that there is a dramatic linear pattern between family income and children’s development 248

UPLIFTING THE B40 ECONOMY

outcomes related to health and social and emotional functioning (Gershoff et al., 2003). The factors are caused by a lack of (i) exposure to books, language barriers, (ii) stability in terms of income and health, and (iii) positive academic role models (Carter, 2012). One of the other major concerns to some B40 youth that cause some reluctance in pursuing their studies is related to finance and cost (Kondylis & Manacorda, 2012). If they are not being helped, their future generation may live in the same economic position, and this will result in prolonged financial insecurity in the family. This issue can be tackled by providing them with access to education and support with financial aids. The poor youth will be able to continue to tertiary education when the universities launch generous financial aid policies for students (Carter, 2012). A program in a university that provides soft skills and academic development will positively benefit students’ development. Few academic programs that work on the purpose of alleviating poverty had been studied by previous researchers and the framework has been constructed as a foundation of knowledge literally. In Malaysia, with an aim to alleviate poverty, the focus has been on the issue of socio-economic inequalities, which had been implemented by expanding the economy. In pursuing inclusiveness, the approach is anchored on two objectives: (i) enabling equitable opportunities for all, and (ii) providing a social safety net for the disadvantaged groups (Zulkarnain, et al., 2013). Among others, education was being emphasized as the researcher indicated that young people from rural areas should be given the technical and vocational training as they are the backbone of the workforce. The Malaysian government spent millions of ringgits to ensure the poor, especially those in urban areas are well treated and received equal attention as others. In converging to the B40 development, skills program, and related courses that focus on various levels of society, ordinary residents, leaders, ladies, and youth are planned based on the specific goal(s) and focus (Sabran, 2003; Saboor, 2015). A study showed that courses and training framework with specific educational modules are able to provide sustainable capacity for the poor (Huafeng, 2014; Saboor, 2015). The courses and training have a direct impact on strengthening human capital development in the long run. This study is aligned with other research findings that emphasized courses, training, and development of human capital as the most important component of the community development model, which is able to eventually reduce poverty (Khoo et al., 2018). In aligning with the Malaysian government’s efforts, UiTM plays its role since 1963 and currently still has been running the CSR project of the prediploma program as a model to uplift the economic position among the B40. The PPT has shown its success in providing a platform to the B40 students. Students’ progress and advancement in their studies have been analyzed from diploma to bachelor’s degree, master’s degree level, and up to Ph.D. 249

A I N I JA PA R E T A L .

As evidence, there are three students who are currently pursuing their Ph.D. in the Faculty of Business Management and Education. The number of students who have been progressing well from pre-diploma up to the Ph.D. level between 2010 and 2018 was so encouraging. It can be noted that 86% or in other words, a large number of students who underwent this program successfully completed their diploma. A number of students who pursued and completed their bachelor’s degrees are still being traced. We believe that the number of students who pursued bachelor’s degrees is more than the figure in our record as some of the students may continue their studies in other universities. On the other perspective, this shows that this program produced a workforce, which leads to an increase in productivity. It would be able to push the country’s production function outward, leading to economic growth. Having understood the CSR program contributed to help the community and need to be sustained, the next section outlined the methodology and discussion of this study.

17.4 Methodology This study comprises theoretical and empirical exercises made up of three main steps such as: 1 2 3

knowledge acquisitions; obtaining and gathering of data; data analysis and validation.

Theoretical and knowledge acquisition involved reviewing of theories, adopting, and relating them to the subject matter investigated. Reviews on theories and previous work have been presented in the literature review and the selected framework has been selected and adapted. Subject matters in this context are the pre-diploma program and staff in a few departments that execute the recruitment programs. Data gathering involves focus group discussions and interviews with PPT offices and staff nationwide. PPT coordinators and supporting staff have been interviewed to distinguish commonness and differences especially on the aspects of implementation, relationships with the state government, and other government agencies. Operational documents have also been examined and classified. From the interviews, generic parameters have been attributed and further analyzed. The final steps were to draw the framework by prioritizing the parameters. The parameters have been converted as components, relationships, or links. Each of the component’s roles had been figured out, constructed, and formed into a few segments. In the first step, mapping knowledge into components and parameters had been done. Overall, these parameters lead to 250

UPLIFTING THE B40 ECONOMY

the construction of ten components and their type, roles, and segments. The last step was a validation task. The directors and senior staff have validated and commented on the framework and improvements have been made to the flow and arrangement of the components. 17.4.1 Parameters identified and attributed Table 17.1 shows ten parameters that have been identified and attributed. Four parameters were external, which means that they are external bodies or agencies outside the university. Eight were internal as they are part of the university system like PPT HQ offices and faculties. There was only one target or product, which is a student who compiled three categories of students who are B40, indigenous pupils, and athletes. Two main academic providers were the faculties. Financial aid contributors were identified as funders and they come from internal and external bodies. Two receivers were those who received the “products” after they completed and passed the pre-diploma examination. Four operators were the PPT offices and the staff plays an active role in executing the PPT operations. In the next section, each of the parameters will be treated as components and linked to each other to describe the working mechanism. But before Table 17.1 Generic Parameters and Their Utility

1

2

Parameters

Roles

Type

Category

B40 youth Athlete Orang Asli (indigenous) PPT main office Headquarters Staff: Director Head of Academic Fellows Registrar Staff

To receive education To join the remedial program

Product

Target

To manage, organize, standardize, Internal and monitor PPT operations nationwide To organize and conduct outreach program, recruit and monitor the B40 students To produce offer letter to the candidates To distribute and process application forms To validate student’s eligibility and B40 status via documents submitted To communicate with funder and other stakeholders To plan and execute outreach program

Operator

(Continued)

251

A I N I JA PA R E T A L .

Parameters

Roles

Type

Category

3

Faculty of Applied Science

Internal

Provider

4

Faculty of Business and Management

Internal

Provider

5

State campuses PPT offices Staff: Coordinator Staff Financial aid contributors Undergraduate program Postgraduate program PPT friends

Program owner for Pre-Diploma Science To design and construct the syllabus Program owner for Pre-Diploma Commerce To design and construct the syllabus To be in charge of student’s registration, validate student’s eligibility and B40 status To run the pre-diploma program

Internal

Operator

6 7 8 9

10

Collaborators Sport Center JAKOA

To provide six months financial aid to the students To receive PPT students at diploma level To receive undergraduate students

Internal Funder External Internal Receiver Internal

Receiver

External Operator To help PPT in disseminating information about pre-diploma program To assist PPT in conducting motivation and outreach programs To assist PPT in validating and Internal Operator selecting candidate External To assist PPT in identifying, providing financial aid, and monitoring the students’ progress

that, the distributions of the students need to be studied as that will show how state campuses play important roles in accommodating students with a conducive academic environment and support system. 17.4.2 Campuses and students distributions Thirteen state campuses (will be referred to as Anchor 2) are working closely with the PPT HQ (will be referred to as Anchor 1). They are important operators that manage approximately 3,000 students per year. Out of 13, 4 campuses run pre-diploma science, 12 campuses run the pre-diploma commerce, and 4 campuses run both tracks. Figure 17.1 shows the distribution of students across Malaysia between 2010 and 2018. The record shown in the following chart shows statistics of students up to March 2018. The total number of students was 30,085. Next, Figure 17.2 shows the campuses that run the program based on tracks. 252

UPLIFTING THE B40 ECONOMY

Figure 17.1 Distribution of students across Malaysia between 2010 and 2018.

17.5 Discussion Major components of the framework are of two types, which are internal and external. The internal components are entities that worked and operated within UiTM, or in other words, they are part of UiTM units or divisions, while the external components are those who are not part of the university system, such as the state government and companies. PPT headquarters and state campuses are two main internal entities that play a major role in managing, monitoring, and executing the PPT program for the students. PPT headquarters (HQ) is the main operator, which is also an anchor in the framework. In identifying the structure, the components are classified into four pillars. The purpose is to simplify and illustrate the formation of respective relationships. The categories are (i) operator, (ii) funder, (iii) provider, and (iv) receiver. Anchors 1 and 2 are the operators that liaise directly with students and parents. Figure 17.3 summarizes the associations and illustrates how these four pillars contributed to the target. This diagram shows that huge efforts have been made to help the target. Thirteen state campuses were working closely with the PPT HQ, and they were also the most important operators that manage approximately 3,000 253

A I N I JA PA R E T A L .

Perlis Campus

East Malaysia

Kedah Campus

Kangar

Kelantan Campus

Kedah

Terengganu Campus George Town

Kelantan

Penang Campus

Terengganu Campus

Terengganu Perak

Perak Campus Selangor Campus

Pahang Campus Pahang Kuala Lumpur Putrajaya

N. Sembilan Campus

West Malaysia Negeri Sembilan Melaka Johor

Melaka Campus

West Malaysia

Johor Campus

Sabah East Malaysia

Sarawak Campus Sabah Campus Sarawak

Pre Diploma Commerce Pre Diploma Science Pre Diploma Commerce & Science

Figure 17.2 State Campuses and Pre-Diploma Program.

students per year. Students were equally assigned and accommodated to each campus based on availability and academic facilities like hostel, classroom, and number of lecturers. Roughly, the maximum number of students in each class is 28 pax. To closely monitor the student’s academic progress, they will be grouped into ten to fifteen students per academic advisor. The academic advisor will also be taking care of them beyond class activities such as on co-curricular activities, finances, and other related welfare issues. 254

UPLIFTING THE B40 ECONOMY Undergraduate & Postgraduate Programmes

2

Anchor 1: PPT HQ Anchor 2: Branch Campus

Receiver

Operator

4

Funder

1

Target

B40 Athlete Indigenous

2

Provider

Faculty of Applied Science

State Goverment GLC (Sime Darby Foundation) Individual (University staffs and public) UiTM (MASMED, Zakat, Wakaf and Sadoqah Unit, ICEPS)

Faculty of Business Management

Figure 17.3 The Four Pillars of the PPT Framework.

Academic rules and guidelines are taken care of by the PPT coordinator who is closely working with the PPT headquarters and Academic Affairs Department. Lecturers who teach the pre-diploma students are those who attached to the faculties and their wise experiences in teaching help the students achieve better academic performance. After completing the six-month program, the students who pass with minimum CGPA 3.50 and above will be offered to continue their studies in the diploma program offered by UiTM, and their placement will be based on the campuses that offer the courses. Figure 4 draws the blueprint of the PPT framework. The framework comprises the main component, which is the pre-diploma program and it encompasses the four pillars. The framework is divided into three main divisions, which are: (i) the students – the b40, athletes, and Orang Asli (indigenous pupils); (ii) the pre-diploma program; and (iii) the higher education programs for diploma, bachelor’s degree, master’s degree, and Ph.D. The flow in the framework starts with an outreach program organized by the anchors. The outreach program was also helped by collaborators among the PPT friends who have direct contact with B40 students and families. The PPT friends are schoolteachers and counsellors, community leaders, alumni, and other voluntary organizations such as charity body, non-governmental organizations (NGO), semi-government agencies, and others. In a year, the two main anchors organize more than one hundred visits to schools both in urban and rural areas. The applications are processed manually by the PPT HQ and state campuses. Applications from the athletes will be verified by the UiTM Sports Center. For the indigenous, Department of Orang Asli Development (JAKOA), which is a specialized department under the Ministry of Rural Development, will identify, select the students, and submit the application for further action. 255

A I N I JA PA R E T A L .

Next component that plays an important role is the faculty. Faculty of Applied Science and Faculty of Business and Management are the program owners that design the syllabus and assign lecturers. Experienced lecturers will take care of each student as per their specific learning needs. They will also identify and understand students’ core problems in each subject. Based on previous experience, these students require more intensive teaching and learning approaches and they are required to be guided closely.

Students

Outreach Task Force

B40

UiTM Sport Center

PPT HQ & State Campuses

Athelete Indigenous (Orang Asli)

JAKOA

Outreach programmes PPT Friends

Organization, volunteers, Alumni, School Counsellors

6 Months Pre Diplamo Programme 7 campuses Pre Diploma Science

Faculty of Applied Science

12 campuses Pre Diploma Commerce

Faculty of Business Management

Financial Aid UiTM Center of Waqaf, Zakat & Sadoqah

Staffs ICEPS Donation

MASMED

State Government & Foundation

Government Link Company

Individual Contributions

Higher Education Programmes Undergraduate Diploma Bachelor Degree

Post Graduate Master Degree PhD

Figure 17.4 The Blueprint Framework of the UiTM PPT.

256

UPLIFTING THE B40 ECONOMY

Funders for PPT are from internal and external sources. Students are assisted with the financial aid that covers monthly allowances, transportation, and tuition fee, which is up to RM1,700 per semesters. The amount ranges from RM150 to RM290, provided twice a month and the exact amount was given based on their family household income. The fund internal sources are Center of Waqf, Zakat, and Sadoqah, Malaysian Academy of SME & Entrepreneurship Development (MASMED) and Institute of Continuing Education and Professional Studies (iCEPS). In addition to that, the most sentimental contributions are sadoqah that come from a salary cut of university staff who have agreed to have a certain amount of money voluntarily deducted from their monthly payslips. The staff range from the lower level staff such as security personnel, assistance police, clerical, and admin staff as well as the academic ones as lecturers and higher management staff. Apart from that, the university also supports B40 students with a fee waiver. This aspect shows that Islamic social finance contributes hugely to the agenda of poverty eradication. Components of zakat and sadoqah in the PPT constitutes an institutional blueprint for long-term development. On another positive note, this effort is independent of the government budget. The mechanism is not only very sustainable but also have the potential to grow over. On the other hand, the main external source that also contributes to corporate social responsibilities comes from a government-linked company (GLC). Sime Darby Foundation (Yayasan Sime Darby – YSD) is the main contributor. YSD has been very supportive toward the less fortunate, and in this context, the contribution is specifically to the B40 students who undergo the PPT program. UiTM receives a yearly allocation of RM2million for one-year intake and to date, the YSD has been allocating RM6million in total in three consequent years. YSD plays its biggest roles in these initiatives as the organization believes that financial aid will reduce the gaps in access to quality education among the students. Other funders are the state government foundation such as Yayasan Pahang (translated as Pahang State Foundation), government-linked companies, and individuals. These funders contribute funds to the PPT on demand basis. For the indigenous, they are well managed by JAKOA. It is a matter of policy that students among the Orang Asli who pursue their education at secondary and tertiary levels receive financial aid directly from JAKOA. The main receiver in the framework is the under- and post-graduate students. PPT considers a direct feeder to the university program. Undergraduate programs cover diplomas and degrees, while postgraduate programs provide continuous higher learning education at master’s degree and the Ph.D. level. Based on the tracer study, the achievement of the students shows that the PPT education framework meets its objectives as it gives

257

A I N I JA PA R E T A L .

opportunities to the youth from the B40 family to pursue their tertiary education (Jaapar et al., 2019).

17.6 Concluding remarks This study analyzed each of the components that make up the PPT framework that embraced association and integration of internal and external operators, providers, funders, and the targeted component who are the B40 youth. PPT unassumingly has been running this systematic framework for the past ten years and produced 40,916 students nationwide. The alumni of the PPT program graduated and are now spreading out all over the country and contribute not only to the family but also have become part of the human capital that builds the economic development of Malaysia. The investigation identified and drew the blueprint of the framework of a program that started small CSR projects. After years, the tracing indicates that the PPT education platform denotes remarkable success in terms of numbers of the workforce in the country as well as helps to increase the economic growth of the B40 in Malaysia. It is also being noted that Islamic social finance, specifically zakat and sadoqah played an important role in making the framework workable and realistic. On another project, PPT continuously informs and motivates students about where the allowance comes from as that will encourage them to study hard. Psychologically, PPT has the intention to make students independent in the future. They should work hard in advancing their own economies so that they can eventually remove themselves from the chains of poverty in the future. As a concluding remark, this blueprint proves that UiTM contributes to one of the main agendas of the government’s efforts in transforming the nation’s development.

References Carter, M. R., & Lybbert, T. J. (2012). Consumption versus asset smoothing: testing the implications of poverty trap theory in Burkina Faso. Journal of Development Economics, 99(2), 255–264. eKasih. (2014). Unit Penyelarasan Pelaksanaan (ICU), Jabatan Perdana Menteri, Kuala Lumpur. http://murninet.townplan.gov.my/murninetsv2/page/et2-p2kadar-kemiskinan%20N (Accessed 13 Aug 2019). Gershoff, E. T., Aber, J. L., & Raver, C. C. (2003). Child poverty in the United States: an evidence-based conceptual framework for programs and policies. In Lerner, R. M., Jacobs, F., & Wertlieb, D. (eds.), Handbook of Applied Developmental Science: Promoting Positive Child, Adolescent, and Family Development through Research, Policies, and Programs, Vol. 2. Thousand Oaks, pp. 81–136. Thousand Oaks, CA: Sage Publications. Hassan, O. R., & Rasiah, R. (2011). Poverty and student performance in Malaysia. International Journal of Institutions and Economies, 3(1), 61–76.

258

UPLIFTING THE B40 ECONOMY

Hatta, Z. A., & Isahaque, A. (2013). Poverty Reduction Policies in Malaysia: Trends, Strategies and Challenges Asian Culture and History, Vol. 5, No. 2. Canadian Center of Science and Education. ISSN 1916-9655, E-ISSN 1916-9663. Huafeng, Z. (2014) The poverty trap of education: education–poverty connections in Western China. International Journal of Education, 38(c), 47–59. https://doi. org/10.1016/j.ijedudev.2014.05.003. Jaapar, A., Salleh, S. S., Mahzar, M., Omar, M. K., Endut, N. A., & Shahril, M. (2019). Tracing pre-diploma students of low-income families: education advancement and continuation of tertiary studies, FEIIC-International Conference on Engineering Education and Research 2019, Kingdom of Saudi Arabia. Khoo, S. L., Samsurijan, M. S., Gopal, P. S., Malek, N. M., & Hamat, Z. (2018). Urban poverty alleviation strategies from multi-dimensional and multi-ethnic perspectives: evidences from Malaysia. Kajian Malaysia, 36(2), 43–68. https://doi. org/10.21315/km2018.36.2.3. Kondylis, F., & Manacorda, M. (2012). School proximity and child labour: evidence from rural Tanzania. Journal of Human Resources, 47(1), 32–63. New Strait Times, Time for Malaysia to lead Islamic social finance endeavours, November 30, 2019 @ 6:21pm. https://www.nst.com.my/opinion/columnists/ 2019/11/543461/time-malaysia-lead-islamic-social-finance-endeavours (Accessed 6 Jul 2020). Saboor, A., Manzoor, M., & Khan, A. U. (2015). Time use poverty and gender inequality: empirical evidences from Punjab. Quality & Quantity, 50(1), 421–438. https://doi.org/10.1007/s11135-014-0156-y. Sabran, M. S. (2003). Model Pembangunan Komuniti. Pertanika Journal of Social Sciences & Humanities, 112, 135–145. Wadsworth, M. E., & Rienks, S. L. (2012) Stress as a mechanism of poverty’s ill effects on children: making a case for family strengthening interventions that counteract poverty-related stress. CYF News, July. American Psychological Association. https://www.apa.org/pi/families/resources/newsletter/2012/07/ stressmechanism (Accessed 10 Dec 2019).

259

18 AN INCREASING DEMAND FOR HALAL PRODUCTS AND SERVICES A call for the enactment of an international convention on halal industries Ibrahim Danjuma 18.1 Introduction The global halal market has emerged as a new growth sector in the global economy and is creating a strong presence in developed countries. The most promising halal markets are the fast-growing economies of Asia, Middle East, Europe, and the Americas. With a growing consumer base, and increasing growth in many parts of the world, the industry is set to become a competitive force in world international trade. The halal industry has now expanded well beyond the food sector by further widening the economic potential for halal (Hussein, n.d.). Halal is an Arabic word meaning lawful, legal, and permitted. This halal concept comes from the Holy Qur’an, which it uses to describe objects and actions. Islam is a natural way of life and encompasses the concept of an economic system based on human cooperation and brotherhood, which is based on consultation and dietary laws for all humanity (Hussein, n.d.). The halal requirement is an important concept among Muslims that assumes a vital role in their daily consumption. Currently, the concern for halal is not only present among Muslims, but the awareness has also extended to the non-Muslims as well. Halal is a code of authenticity that a product, service, and the production process conform to the Islamic shari’ah (Talib & Moh’d, 2012). Halal products are beneficial to a nation’s economic development in terms of its contribution to gross domestic product (GDP) as clearly demonstrated by a multi-racial country like Malaysia. This should prompt developing nations, such as Nigeria and others, to provide ethical and healthy products for both Muslims and non-Muslims in the country by using Malaysia as a role model (Oyelakin & Yusuf, 2018).

260

DOI: 10.4324/9781003050209-18

I N T ER NAT IONA L C ON V EN T ION ON H A L A L I N DUST R I E S

Taking halal food and products is a religious obligation upon each and every Muslim as Holy Qur’an 2 Verse 168 provides that “o ‘Ye people, eat what is on earth halal and Thaiyiban (wholesome) and do not follow the footsteps of the evil one, for he is to you an avowed enemy.” Similarly, Qur’an 5 verse 2 forbids Muslims from taking a dead animal, blood, or the flesh of swine (pig) among others. Despite these prohibitions, there are some prisons in the United States that deny Muslim Inmates Halal food (Ettachfini, 2019). Similarly, a study reveals that numerous Muslim inmates in the U.S. prisons face obstacles to practicing their religion because most of the prisons refuse to comply with the Islamic dietary restrictions (Ettachfini, 2019). In some cases, the U.S. prisons starve Muslim inmates during Ramadan by giving them pork sandwiches and refuse to provide them with enough calories to sustain themselves while fasting (Ettachfini, 2019). One question that is likely to be asked is that ‘has this attitude of the U.S. prison authorities being penalized or is there any sanction to that effect? In a related infringement of the Muslim’s right to freedom of religion, McDonald’s in 2013 paid a sum of USD700,000 as compensation to one Ahmed Ahmed and Muslims living in Dearborn for serving them non-halal chicken. It was reported that one of its franchise restaurants in Michigan falsely advertised its food that it had been prepared according to Islamic dietary laws (Daily Mail). Will the compensation paid to those who falsely consumed halal food adequately compensate them and also serve as a deterrence to other potential violators? These are some of the issues that call for the enactment of the international convention on the halal industry, which will be discussed later. It is in view of the above that this chapter examines the concept of halal product and services, history and growth of the halal industry and the market, importance of halal products as well as the need for the enactment of the international convention with regard to halal products and services.

18.2 Halal products and services It is important to note that the Islamic dietary and consumption system are different and unique compared with other ethnic dietary systems. The world community has now begun to understand the importance of the Muslim requirements for food and other consumption known as halal. Many foods are clearly halal or haram. However, certain foods are difficult to classify because of the ingredients they contain. Check for halal certification or read food labels. Carefully check each time you buy food products, as manufacturers may change ingredients without notice. For meat and poultry to be halal, they must be slaughtered according to Islamic

261

I brahim D anjuma

dietary laws (Toronto Public Health). Therefore, halal products and services are categorized as follows: 18.2.1 Food The largest opportunity within the halal market is undoubtedly food, which is also where the greatest challenge lies. The halal marketplace is emerging as one of the most profitable and influential market arenas in world food business today. The halal food market has grown strongly over the past decade and is now worth an estimated USD667 million. Halal food represents close to 20% of the entire global food industry. With expected increases in both population and income of halal consumers, and coupled with the expected increase in demand for food by more than 70% by 2050, the future demand for halal food is strong (Halal Research Council). Many food economists posit that the halal food industry will become a major market force in the near future based on four prevalent trends (Halal Research Council). Firstly, Islam is now the fastest-growing religion in the world, fueling the global demand for halal products. The annual growth in the consumption of halal food is estimated at 16% (Halal Research Council). Secondly, the increasing trend of consuming halal food products is also ethical and safe for non-Muslim consumers. In the UK, for example, there are over 2 million Muslims, yet there are 6 million consumers of halal meat (Gregory, 2008). Halal food products are not confined to meat and poultry; they also include other food items such as confectionery, canned and frozen food, dairy produce, bakery products, organic food, beverages, and herbal products. 18.2.2 Pharmaceutical and health products Pharmaceutical and health products are also large growth areas in the global halal industry. The demand for halal pharmaceutical, generic medial, wellness, and healthcare products are estimated to be about USD555 billion in Muslim-majority countries. However, the halal pharmaceutical market is plagued by the lack of global halal standards on pharmaceutical ingredients and product integrity analytical methodology (Ying & Partner, 2011). The main concern among Muslims is the use of non-compliant substances such as animal derivatives and animal-based gelatins in these products. The global market growth for pharmaceuticals increased by 4% in 2009 to a value that exceeded USD820 billion, offering vast potential opportunities for the halal pharmaceutical industry to tap into (Azmi & Akram, 2012). The rising healthcare costs also provide the halal market with a key differentiation factor in the supply of generic pharmaceuticals (Azmi & Akram, 2012). Thus, a pharmaceutical product should not only be halal but should also be judged clean according to shari’ah law (Azmi & Akram, 2012). 262

I N T ER NAT IONA L C ON V EN T ION ON H A L A L I N DUST R I E S

Malaysia introduced the world’s first ever standard for halal pharmaceuticals in the year 2011 code-named MS2424:2010. This standard draws various guidelines in the areas of manufacturing and handling of pharmaceutical products to ensure that the final product is in accordance with the shari’ah law. The global market for halal pharmaceuticals is reported to be worth more than USD800 billion, with an expected annual growth of approximately 6% (Ying & Partner, 2011). Growth in the halal cosmetics market is mirrored by a growth in consumer knowledge about the ingredients used and product awareness, fueled by social networks (Hunter, 2012). The global halal cosmetic industry is estimated at USD13 billion with an annual growth rate of 12% (Institute of Personal Care Science of Australia). At present, the halal cosmetics market constitutes 11% of the total global halal industry. The emerging halal cosmetic and personal care market is seen by analysts as the next in line for growth after the lucrative halal food sector. Halal cosmetics have developed far beyond a novelty. Capitalizing on the burgeoning halal cosmetic market, a number of cosmetic companies are beginning to develop this niche market by producing halal-certified product lines that contain no animal ingredients, and not tested on animals to meet the growing demand of consumers who simply want more assurance that the cosmetics they are using are healthy and sustainably sourced (Halal Research Council). Cosmetics are considered to be halal only when all the ingredients comply with the halal and shari’ah requirements while haram ingredients like alcohol and materials derived from pigs are not used in their preparation. Moreover, all ingredients must be manufactured, stored, packaged, and delivered in accordance with strict halal standards. There are various estimates about the current size of the halal cosmetics market ranging from USD5 billion to USD14 billion sales per annum (Hunter, 2012). These estimates probably vary due to the different definitions of what constitutes halal products (Hunter, 2012). 18.2.3 Tourism Halal tourism is a subcategory of religious tourism, which is geared toward Muslim families who abide by shari’ah rules. The hotels in such destinations do not serve alcohol and have separate swimming pools and spa facilities for men and women. These hotels offer prayer rooms, halal certificates for food, and, in general, a Muslim-friendly environment. It is commonly associated with Middle Eastern countries, especially when it comes to Hajj and Umrah packages for pilgrims. Muslims all over the world travel to Mecca and Medina annually to perform the Hajj (Islamic Pilgrimage). The verses of the Qur’an endorse traveling with a view to achieving spiritual, physical, and social goals. Tourism is thus harmonious with Islam and in fact, is encouraged 263

I brahim D anjuma

by its teachings, but at the same time, the religion demands obligation to the teachings regarding dress, conduct, food, prayer, etc. (Wikipedia, 2012). Halal tourism has recently gained popularity and is now fast becoming a new phenomenon in the general tourism industry. It refers to tourism products that provide hospitality services in accordance with Islamic beliefs and practices (Wikipedia, 2012). Malaysia, for example, has been leading the way in the halal tourism industry and has been successful in attracting Muslim tourists from all over the world, especially Middle Eastern travelers. Recently, Malaysia was ranked first among the top 10 halal-friendly holiday destinations in the world (CRAHFT Ranking, 2013). The ranking was based on several factors including the availability of halal food, prayer facilities, and halal-friendly accommodation (CRAHFT Ranking, 2013).

18.3 History of the halal industry Developing countries such as Indonesia and Malaysia are the highest halal food consumption regions with a Muslim population of 248.5 million and 29.8 million, respectively. Malaysia has moved forward in the halal industry among the ASEAN members. Thailand is a country with a lesser Muslim population, but the demand for halal food has increased by about 20% annually. These counties are rich in natural resources and have the capability to produce halal food. The ecosystem is mostly focused on products (Wacharanjirasophon, 2016). As a progressive Muslim country with a consistent economic development and growth rate as well as political and social stability, Malaysia is the leader and pioneer in the halal industry began in 1974 when the Research Center for Islamic Affairs Division in the Prime Minister’s office started to issue halal certification letters for products that met the halal criteria (Business News, 2015). From the selected developing countries, undoubtedly, Indonesia is the biggest market in Asia for halal products. With more than 210 million Muslims, it is an opportunity that the foreign firm cannot resist (Ismail, 2015). Based on the 2013 Data, Indonesia is the highest country for Muslim food consumption with USD 190 million followed by Turkey and Pakistan (Ismail, 2015). The first halal standard released in 2,000 was an important milestone for Malaysia as it became the first country to have a documented and systematic halal assurance system. The standards become the impetus to a new revolution that had transformed halal, from strength to strength, from a traditional cottage industry to a vibrant new economy with an estimated global market value of USD2.30 trillion (Islamic Tourist Centre, 2015). Malaysia is an emerging country that successfully developed its industry in Islamic banking and finance. Many countries such as Indonesia, 264

I N T ER NAT IONA L C ON V EN T ION ON H A L A L I N DUST R I E S

Thailand, Bosnia, Nigeria, and Algeria refer to Malaysia as a hub of Islamic finance, with the durability of its halal industry (Islamic Tourist Centre, 2015). Malaysia is expanding its halal industry into different sectors such as Islamic tourism and halal food. A strong platform to develop halal food industry in Malaysia is conducted through workshops and research to produce compatible human resources (HR) and provide halal standardization by the Department of Islamic Development Malaysia (JAKIM), which has become the reference forum for halal food certification in Japan (Wacharanjirasophon, 2016). Furthermore, for nearly 15 years, Malaysia regularly held Malaysian International Halal Showcase (MIHAS). In 2016, MIHAS welcomed over 22,000 traders and visitors from more than 70 countries and generated a record sale of more than RM1 billion for 600 exhibitors (Wacharanjirasophon, 2016). The rapid development of halal certification in Malaysia has also prompted JAKIM to extend its halal section into a much bigger organization in 2005, officially named JAKIM’s Halal Hub. JAKIM was the world’s first halal certification body responsible for monitoring the halal industry, leading to the amendment of Malaysia’s Trade Description Act in 2011, which gives JAKIM a much stronger mandate to regulate the halal industry (Islamic Tourist Centre, 2015). JAKIM recognition program for international halal bodies is the most stringent and sought-after bilateral halal system recognition program in the world with over 50 international bodies registered to date (Islamic Tourist Centre, 2015). The iconic Malaysia’s halal logo is the most sought-after, globally recognized hallmark that serves as an emblem for the country’s reputation as the world’s leading halal hub (Islamic Tourist Centre, 2015). Realizing the vast economic potential of the halal industry, a development agency named the Halal Industry Development Corporation (HDC) was also formed under the Ministry of International Trade and Industry (MITI) in 2008 (Islamic Tourist Centre, 2015). According to the Islamic Tourist Centre (2015), the agency is tasked to develop Malaysia’s industrial capacity and bring in foreign direct investment (FDI) into the country. Malaysia plays host to two of the most important annual events in the halal industry, namely, the Malaysia International Halal Showcase (MIHAS) and the World Halal Forum (WHF). Both play a pivotal role in building the country’s reputation as the global reference and trade center for a new mainstream halal industry since 2003 (Islamic Tourist Centre, 2015). With the government’s full support and earnest involvement, Malaysia’s credibility and leadership in the halal sector is also recognized by the Organization of Islamic Cooperation (OIC). Although Thailand has the least Muslim population compared with Malaysia and Indonesia, the Thai government urges the development of Thai halal food products to help boost export; as the fifth-largest halal food exporters in the global market, Thailand is known as the country offering 265

I brahim D anjuma

investors, strong government support, rich agricultural resources, skilled labor, and excellent infrastructure (Wacharanjirasophon, 2016). Food processing is the core strength of the Thai industry. According to Wacharanjirasophon (2016), in 2011, Thailand has exported halal food to 57 Islamic countries and achieved approximately 68 billion dollars, as the world’s demand for halal product kept increasing and had grown by 12.1% in 2012. Despite the fact that Islam is not the main religion in Thailand, the government of Thailand had proposed to establish Thailand as a halal food hub in 2003 with the purpose of developing product quality, certification, marketing strategies, and to enhance competitiveness (Rininta, 2017). Today, Malaysia is the leading global halal hub with an annual export value of RM35.4 billion for halal products, which contribute to approximately 5.1% of the total export of the country (Islamic Tourist Centre, 2015). The country provides the world’s first halal in-flight catering onboard its national carrier, Malaysia Airlines (Islamic Tourist Centre, 2015). Islamic Tourist Centre (2015) reports that the Malaysian halal standard is now being widely used by several renowned global multinational companies (MNCs) including Nestle, Colgate, Palmolive, and Unilever. Malaysia’s halal portfolio has also expanded beyond food and beverages, venturing into various other sectors such as cosmetics, logistic, pharmaceuticals, and most recently, tourism. There is no end to the variety of halal products and services that can be found in Malaysia: from halal food to Islamic banking, Malaysia provides end-to-end halal goods with a universal appeal. Vis, coupled with a conducive environment and government-backed policies and initiatives, strengthen Malaysia’s position as the nucleus of the global halal industry (Islamic Tourist Centre, 2015).

18.4 The growth of the halal market The market for certified halal food and products is growing robustly, both domestically and internationally. Although the term “halal” has never attracted as much attention as in recent times, today wherever there are Muslim consumers whose tests and reference ranges are governed by halal rules on food specification (Zakaria, 2008). The popularity of and demand for halal-certified products among non-Muslim consumers have been on the rise as more consumers are looking for high-quality safe and ethical products. The halal market provides a huge potential for companies’ organizations and others, from the west and from the Muslim countries and is on a path of steep growth. The Muslim population is expected to grow by about 35% over the next 20 years, rising from 1.6 billion in 2010 to 2.2 billion by 2030 or 26.4% of the world’s total projected population of 8.3 billion by 2050 (Majlis, 2011). The Muslim population could grow to 2.6 billion and represent nearly 30% of the global projected population. 266

I N T ER NAT IONA L C ON V EN T ION ON H A L A L I N DUST R I E S

The global halal market of 1.8 billion Muslims is no longer confined to food and food-related products. The halal industry has now grown beyond the food sector to include pharmaceuticals, cosmetics, health products, toiletries, and medical devices as well as service sector components such as logistics, marketing, print and electronic media, packaging, branding, and financing (Majlis, 2011). In recent years, with the increase in the number of affluent Muslims, the halal industry has expanded further into lifestyle offerings including halal travel and hospitality services as well as fashion. This development has been triggered by the change in the mindset of Muslim consumers as well as ethical consumer trends worldwide (Dar, 2013). The halal market is non-exclusive to Muslims and has gained increasing acceptance among non-Muslim consumers who associate halal with ethical consumerism. As such, the values promoted by halal – social responsibility, stewardship of the earth, economic and social justice, animal welfare, and ethical investment – have gathered interest beyond its religious compliance (Dar, 2013). The popularity of, and demand for, halal-certified products among non-Muslim consumers have been on the rise as more consumers are looking for high-quality, safe, and ethical products (Dar, 2013). Recent research has shown that the halal industry is now gaining global attention (Mathew et al., 2014). This is evidenced by the annual increase of market share in the halal industry worldwide. According to Mathew et al. (2014), the increase in the industry is estimated at 20% yearly, which is worth about 2.3 trillion (excluding Islamic finance). Interestingly, halal products have gained confidence and trust even in the heart of non-Muslims consumers who see the product as safe, of high quality and more ethical (Mathew et al., 2014). Currently, the forces and prospects of the halal market are so enormous and are on the increase globally. This is based on the world Muslim population, which was about 1.8 billion in 2012, projected to make up to 26% of the world population of 2.2 billion in 2030 (Mathew et al., 2014). It is also noted that the halal market has grown beyond food-related items and other aspects of products such as health items, cosmetics products, and even services such as logistics, finance, and others, and also included in the scope of the halal industry (Oyelakin & Yusuf, 2018). In view of the above, the growth of the halal market can be summarized under the following headings: 18.4.1 Increasing global competition Countries in Asia, particularly Thailand, Philippines, Singapore, People’s Republic of China, and Australia are capitalizing upon the growth of the halal market. This is reflected by various initiatives being undertaken in this field by those countries, including trade and investment promotion (Halal Research Council, n.d.). 267

I brahim D anjuma

18.4.2 Standard Development of an international halal standard is likely to become a major focus on the halal market during the next five years. Just as the development and implementation of standards assumed a major role within the computer industry, a similar effect in the halal industry can be anticipated. The development and promotion of international halal standards will facilitate potential producers and exporters in gaining control over such markets (Halal Research Council, n.d.). 18.4.3 Increasing demand for product diversity Greater mobility and increased migration of the Muslim communities have contributed to the increased demand for a wider range of halal products. Muslim communities overseas want and expect to acquire foods and services according to their religious tenets, thus, the requirement for halal compliance has become more prevalent (Halal Research Council, n.d.). 18.4.4 Investments According to Halal Research Council (n.d.), during 1996–2005, the total approved investments in the food and selected non-food industries (medical devices, cosmetics and toiletries, and pharmaceuticals) amounted to RM10.2 billion. The Halal Research Council further states foreign investments constituted 5.2 billion Malaysian ringgit and domestic investments, 5 billion Malaysian ringgit. 18.4.5 Institutional support Companies including small and medium enterprises (SMEs) are eligible for a wide range of incentives to support their effort to gain access to the halal market, which include a special grant for the development and promotion of halal products; grants for business planning and development, products and process improvements, productivity and quality improvements; and certification, market development, and brand promotion (Halal Research Council, n.d.).

18.5 Importance of halal product and services Despite the importance of halal to Muslims, issues of forged certificates and logo or closure of premises due to unhygienic production still occurs. As a stakeholder, Muslim consumers should be able to exercise their power when they consider halal issues are very important to them (Nik & Nik, 2014). The importance of halal products and services can be summarized as follows: 268

I N T ER NAT IONA L C ON V EN T ION ON H A L A L I N DUST R I E S

I Countries that have expertise in halal food processes have an opportunity to develop partnerships with non-OIC countries eager to strengthen their halal capabilities. Countries such as China, South Korea, and South Africa are already partnering with Malaysia and the UAE to develop their halal capabilities. II As Muslims, consuming halal products is a necessary obligation and the halal logo plays an important part in enticing Muslim consumers to buy halal products (Dali et al., 2007). Generally, the halal logo is sufficient to show the consumer that a product meets the Islamic standard (Masnono, 2005). III Cleanliness is also important in producing halal consumer products. In Islam, there are specific principles and guidelines to comply with the Islamic shari’ah requirement when producing clean halal products (Hussin et al., 2013). IV Halal products and services are very important because majority of the Muslims of the world are beginning to be aware of the importance of consuming halal products while non-Muslims are looking for a safe, ethical way, which is based on equity and justice and quality products, which are the main characteristics of the halal product (Ambali & Bakar, 2014). V Halal food is important to the global standard for safe, wholesome, humane food if producers fully adhered to the concept of halal and tayyib as in the tenets of Islam (Hussein, n.d.). VI Awareness of consumers toward the importance of halal products and services as well as culture has become one of the aspects that influence people in buying halal products and services due to its suitability (Mohamad et al., 2015). VII Halal products and services give good health and better services to the users using halal sources and Islamic shari’ah (Mohamad et al., 2015).

18.6 Why the need for an international convention on halal product and services? The demand for halal products globally by both Muslims and non-Muslims has increased sporadically and the products have become a global interest and are being given more attention even among countries that are not dominated by Muslims, such as China, Australia, and Brazil. Due to its demand and positive contribution to the GDP for countries who are fully practicing halal, such as Malaysia, Indonesia, and the United Arab Emirates. As a matter of fact, the global halal industry is estimated to be worth about USD2.3 trillion annually among halal product country players, such as Malaysia, Pakistan, UAE, Australia, Oman, Brazil, Jordan, Azerbaijan, Egypt, Qatar, and Indonesia (Abdullah et al., 2017). Based on ranking, Malaysia is seen as number one in the halal industry (Abdullah et al., 2017). 269

I brahim D anjuma

From the foregoing, it can be understood that many countries are players in supplying halal products to the increasing Muslim and non-Muslim population all over the world. Therefore, there is a need for the enactment of an international convention that will synergize the efforts of the government and private sectors to boost the halal industry’s development. Additionally, to enable halal products to penetrate and be acceptable in the European halal market, it will be an excellent platform in charting the course toward a stronger halal economy. Moreover, there is a need for a convention that will focus mainly on the development of the halal industry in eastern European countries, which will aim at increasing halal product exports to the OIC countries, which comprise the main halal food consumer market. Further, the event will be a gathering of international and local top officials in the government and academic, industry leaders, cutting-edge speakers, dignitaries/VIPs, certification bodies, expert buyers, traders, importers, chain stores, and hypermarket, which will provide for a perfect platform to conduct business networking and to get new trade opportunities to enter this lucrative market. It is observed that there is a lack of common and unified standards globally, which causes confusion for multinational companies to enter the halal food market. Further, the need for the enactment of the international convention will be in the form of a multilateral treaty that will establish a uniform framework for the international halal industry. Additionally, the international convention will provide an avenue where the state parties to the convention will undertake to adopt legislative or other measures necessary to ensure the application of the principles promoted by the convention. By organizing a convention on halal food and products, there will be a universally recognized accreditation body that will be issuing halal certifications to companies for recognition by Muslim consumers. And in the event where any of the provision of the convention is breached or violated, necessary action will be taken against the defaulting state party or company. In other words, if an international convention on halal food and products is enacted, it will provide an effective legal remedy and appropriate punishment for the defaulters and to deter potential defaulters not only a mere compensation as in the McDonald’s case in Dearborn.

18.7 Conclusion From the foregoing, halal products and services are beyond food and beverages; they also include cosmetics, pharmaceuticals, and tourism. The development of the halal industry in the world is impressive and demonstrates a positive development towards realizing the country’s aspiration to become a major country in offering halal products to the world. As the industry has grown for so long, there are opportunities and advantages that can be catalysts as well as issues and challenges that need to be handled comprehensively. 270

I N T ER NAT IONA L C ON V EN T ION ON H A L A L I N DUST R I E S

We have examined the concept of halal products and services, history, growth, and importance of halal products and services as well as the need for the enactment of an international convention on halal products and services. Therefore, the findings reveal that the global expansion of halal food products is also attributed to the global growth of the Muslim population as a result of the strong demand from both Muslims and non-Muslims, and halal-certified food products are marketable overseas and are widely accepted in non-Muslim majority countries. Thus, the need for the organization of an international convention with regard to halal products and services is paramount to establish a uniform framework in the halal industry and to provide an effective legal remedy as well as appropriate punishment or sanction to those who refused to adhere to the provisions of the convention. Finally, for the collective benefit of Muslims around the globe, it is important for Muslims to adopt and promote the production of halal food worldwide by advocating for the enactment of an international convention on halal industries to protect Muslims’ religious dietary requirements.

References Abdullah, A., Jaafar, H., & Abd Rashid, A. (2017). A review of Malaysia’s halal trade performance: does distance and Muslim population plays a difference? Proceedings of 47th International Business Research Conference. World Journal of Management. World Business Institute (WBI), Australia. Ambali, A., & Bakar, A. (2014). People’s awareness on halal foods and products: potential issues for policy-makers. Procedia – Social and Behavioral Sciences, 121: 3–25. Azmi, S., & Hadeer Akram, A. R. (2012). Exploring the halal status of cardiovascular, endocrine, and raspatory group of medications. Journal of Medical Sciences, 20(1): 69–74. Business News (2015). Malaysia is the leader and pioneer in the world’s halal industry. https://www.thestar.com.my/business/business-news/2015/11/25/ malaysia-is-world-pioneer-in-halal-industry/ CRAHFT Ranking. (2013). Top 10 Halal Friendly Holiday Destinations. Dali, N., Sulaiman, S., Samad, A. A., Ismail, N., & Alwi, S. H. (2007). Halal products from the consumer’s perception. An online survey. Proceedings of the Islamic Entrepreneurship Conference, 1–12. Economics and Muamalat, Kolej Universiti Islam Malaysia. Dar, H. (2013). Global Islamic Finance Report: GIFR 2013. Edbiz Consulting. Ettachfini, Leila, (2019). Many U. S. Prisons Deny Muslims Inmates Halal Food and Proper Prayer, Retrieved from https://www.vice.com/en_us/article/9kxeyv/ muslim-inmates-us-prisons-halal-food-and-prayer, published by vice.com on 26th July, 2019 and accessed on 10th May, 2020. Gregory, N. G. (2008). Animal welfare at markets during transport and slaughter. Meat science, 80(1): 2–11.

271

I brahim D anjuma

Hunter, M. (2012). The emerging halal cosmetic. Personal care Mar. 37–41. Institute of Personal Care Science of Australia. Retrieved from http://works.bepress.com/ murray_hunter/11. Hussein E. (n.d.). Halal industry: key challenges and opportunities. MPRA Paper No. 69631. Retrieved from http//mpra.ub.uni-muenchen.de/69631/. Hussin, S. R., Hashim, H., Yusof, R. N., & Alias, N. N. (2013). Relationship between product factors, advertising, and purchase intention of halal cosmetic. Pertanika Journal of Social Sciences & Humanities, 21: 85–100. Ismail, R. M. (2015). Global issues and challenges from the halal food industry. In Paper presented on China (Ningxia) International Corporation Forum on Halal Food Certification on September. Majlis, F. H. (2011). The Market Opportunity of the Muslim World. Malaysia-The World Leading Halal Hub. Retrieved from https://itc.gov.my// tour ists/business-news/2015/08/22/halal-m isconception-halal-industr yin-the-country-is-highly-developed. Mathew, V., Amir Abdullah, A., & Mohamad Ismail, S. (2014). Acceptance on halal food among Non-Muslim consumers. Procedia – Social and Behavioral Sciences, 121: 262–271. Masnono, A. (2005). Factors influencing the Muslim consumer’s level of confidence on halal logo issued by Jakim: an empirical study. PhD Thesis, Universiti Sains Malaysia. Mohamad, I. M. R., Alias, Z., Abd Samad, I. H., Naseri, N. Z. A., Ahmad, N. Z. A., & Baharuddin, F. N. (2015). Overview of halal products and services in Malaysia and global market. International Journal of Economics, Commerce and Management United Kingdom, 3(3): 1–9. Nik, Z., & Nik, W. (2014). The importance of halal to Muslim consumers: are they powerful stakeholders? Journal of Applied Environmental and Biological Sciences. www.textroad.com. Oyelakin, I. O., & Yusuf, A. H. (2018). Prospect of halal product in developing countries: comparison between Nigeria and Malaysia. International Journal of Business Society, 2(8): 44–53. Rininta, N. (2017). The global development of halal food industry: a survey. Tazkia Islamic Finance and Business Review, 11(1): 39–56. Talib, M. S., & Mohd, J. M. R. (2012). Issues in halal packaging: a conceptual paper. International Journal of Business and Management, 5(2): 94–98. The Global Halal Industry: An Overview. www.halalrc.org. Accessed 21/11/2019. Wacharanjirasophon, U. (2016). Factors influencing consumer intention to purchase halal food among Muslims in Thailand. Unpublished Master Thesis, Department of Business Administration, Kulliyah of Economics and Management Sciences, International Islamic university Malaysia. Wikipedia. Halal Tourism, 2012. Retrieved from http://en.wikipedia.org/wiki/ Halal_tourism. Ying, C., & Partner, K. (2011). The Malaysian halal pharmaceutical standard. Retrieved from http://asia.legalbusinessonline.com/regional-updates/malaysiawong-partners/the-malaysian-Halal-pharmaceutical-standard. Zakaria, Z. (2008). Tapping into the world halal market. Some discussion on Malaysian laws and standards. Jurnal Syariah, 16(3), 603–616.

272

19 EDUCATION FOR YOUNG GENERATIONS ON HALAL FOOD AUDIT AND CERTIFICATION Challenges and future prospects Hadia Saqib Hashmi and Hassnian Ali 19.1 Introduction Islam is an all-embracing religion in which all social relations are defined and determined. The term shari’ah (Islamic law) literally can be defined as “the way to a watering place” (Rahman I. Doi, 2008). In a technical sense, it is the way and path that must be followed by every Muslim, which governs him or her in passing his or her life to realize the Almighty’s will. It overarches all forms of behavior – mental, physical, and spiritual (Kunhibava & Rachagan, 2011; Laldin, 2006). The objectives of shari’ah usually denoted as maqasid al-shari’ah provide a holistic picture of Islam as a guideline for the life of the individual and society (Dusuki & Abozaid, 2007), encompassing business entities (Abdullah, 2012). In recent years, the debate on the maqasid al-shari’ah has been increasing significantly in a halal economy or industry. Maqasid al-shari’ah indicators are constructed to focus on individual and public interests (Abubakar, 2016). Halal business activities should be aligned with the maqasid al-shari’ah. Due to the speculative behavior of stakeholders, negative psychological and economic effects that occur in halal business activities can be limited through the application of maqasid al-shari’ah indicators (Rafikov & Saiti, 2017). Stakeholders in the halal industry have to assure sustainability by fulfilling the desires and needs of individuals and this can be achieved through the implementation of the maqasid al-shari’ah (Rahman et al., 2017). The global halal industry comprises Islamic finance, halal food, halal travel, halal media, modest halal fashion, halal cosmetics, and halal pharmaceuticals (Thomson Reuters & Dinar Standard, 2018). Among the major segments of the halal industry, halal food is very important and it is crucial that the demand for halal food be addressed since the great number of Muslims around the globe demand the availability and DOI: 10.4324/9781003050209-19273

H adia S aqib H ashmi and H assnian A li

access to halal food all the time and also on a large scale. It is critical for each Muslim individual to ensure that the food he or she is consuming is halal, and therefore, nutritious, healthful, and clean. Halal food is food that is permitted for consumption by Muslims according to Islamic law. All food is considered to be halal, except for that which is clearly identified in Islamic law as non-halal. The education of halal and haram is one of paramount importance with regard to Islamic law, and it is necessary and compulsory for every Muslim to be educated about both halal and haram. Globally, the Muslim population encompasses a large ratio of youth in both Muslim and non-Muslim countries (Emont, 2016). The young generation is more sensitive of their choice of food, clothes, and so on. Education on halal food and especially on the process of halal food audit and certification is imperative for the young as it is their religious obligation to ensure that they consume halal and not haram products. Hence, the aim of this study is to emphasize on the importance of education for the young on halal food audit and certification. 19.1.1 Demystification of the segment of halal food within the global halal industry Most of the Muslim population comprises young ones in the age group of under thirty (Emont, 2016). Meanwhile, globalization has also become the giant pillar of economies across industries. This is supported by the widespread Muslim population worldwide. On the other hand, cultural globalization among religions, ethnicities, and nationalities is also a noteworthy phenomenon from the perspective of the global halal industry, which is growing at an exponential rate and its size has been increasing with each passing year. With a compound annual growth rate (CAGR) of 23%, the global halal industry is valued at $560 billion a year. The total estimated worth of the global halal industry is around $2.3 trillion with the exclusion of Islamic finance. It has been open to expansion and encompasses a number of service industries. Among all sectors, halal food had the highest growth rate with US$1,303 billion in 2017, which is expected to be US$1,863 billion in 2023 (Thomson Reuters & Dinar Standard, 2018). Various types of halal foods are covered under halal products, such as red meat, sea food, fruit, processed food like frozen food, pasta and noodles, canned food, biscuits and cookies, sweets and candies, chocolates, snack food items, spices and seasoning, sauces, jams and spreads, cereals, beverages, and packed dry fruits, nuts, and grains for households. A considerable quantity of halal food products are being supplied to a substantial number of Muslim consumers who form the emerging halal food market. UNO (United Nations Organization) has declared Malaysia as the benchmark for

274

H A L A L F O O D AU D I T A N D C E RT I F I C AT I O N

Table 19.1 Growth of the Halal Industry Facets of the Halal Industry

Growth Rate 2017

Expected Growth Rate 2023

Exports (Thousand)

Imports (Thousand)

Halal food

US$1,303 billion US$177 billion US$270 billion US$209 billion US$87 billion US$12.6 billion

US$1,863 billion US$274 billion US$361 billion US$288 billion US$131 billion US$25 billion

US$124,754, 129

US$191,530,990

US$74,652,194

US$1,054,411

US$2,775,460

US$5,836,593

US$4,267,370

US$26,137,100

USD$4,062,675

US$9,745,902

Halal travel Modest fashion Halal media and recreation Halal pharmaceuticals Halal cosmetics

Source: Thomson Reuters & Dinar Standard (2018).

halal food products in conformity with the general guidelines for the term ‘halal’ issued by Codex Alimentarius Commission in 1997 (SME Annual Report, 2006). The Muslim population is growing rapidly, which will result in the intense focus on and demand for halal food products in countries with Muslim majority. In 2027, the total population of Muslims in the world is forecasted to be 2.1 billion, which constitutes 25.2 of the entire population worldwide. The average age will be increased from 26.4 to 28.2 along with consumption by OIC reaching up to 2.2 billion in aggregate. This correlation has recommenced the ranking leadership of Malaysia from the 5th position in 2016 due to significant developments in the promotion and awareness of halal food (The Global Islamic Economy Indicator (GIEI), 2017). All this sketches the exigency of halal consumption in all different walks of life. Halal food is full of nutrients and does not contain chances of being injurious to health. Halal food contains all the good substances that are consumed by a human on a daily basis, such as vitamins, minerals, proteins, fats, carbohydrates, and water (Henderson, 2016). The main focus of the manufacturer during the entire production and processing of halal food products from farm to folk is to ensure the products are in compliance with the five objectives of the maqasid al-shari’ah as specified by Islam, including preservation of religion, life, intellectual, progeny, and property (Othman, 2017). The terms ‘masalahah’ and ‘ammah’ generally cover all five objectives of the maqasid al-shari’ah (Othman, 2017). The quality of halal food cannot be ensured only using halal ingredients. The whole process from farm to fork shall be checked according to the

275

H adia S aqib H ashmi and H assnian A li

principles and requirement of the shari’ah as the basic purpose of the shari’ah is to improve and promote the welfare of the collective society by eliminating all the elements causing hazards and difficulties to humans and society (Musa & Saifuddeen, 2005). Consumers, producers, and products are the three segments upon which the production and consumption of halal food is based. The food is produced by the manufacturer followed by the steps of being considered, solicited, and consumed as per the need and requirements. A product should be tangible to be distributed well commercially. It goes under multiple steps of manufacturing and fabrication along with passing through a distributional channel until it reaches the hands of the final consumer for use. The person buying the product in retail is known as the consumer (Business Dictionary, 2017). Whereas the company or a person who is producing the goods, whether manufacturing or processing it for sale, is known as the producer (Oxford Dictionary, 2017). It is the responsibility of every Muslim to buy halal products. Thus within the concept of consumerism, Islam covers halal consumers, operators, and products. Consumerism covers everything related to the user, the one who purchases, uses, maintains, and discards the goods or services in the end, achieving the highest level of satisfaction with a limited amount of income (Jamaludin, Kamarudin, & Ramli, 2015). According to Rahim et al. (2013), the whole combination and steps should be strictly in compliance with the comprehensive nature of Islamic law, confirming the maqasid al-shari’ah, which is extensively neglected by incautious parties (Othman et al., 2018). 19.1.2 Muslim population around the globe Islam is the second-largest religion in the world after Christianity (AFP Fact Check, 2019), and it is rapidly growing as compared with other religions, and it is expected that the number of Muslims will surpass the number of Christians in the future. The Muslim population is growing at the exponential rate of 3% per annum with a total approximation of 1.8 billion Muslims. This number will hit 2.2 billion in 2030. There is a clear variation found in the Muslim population in Islamic as well as in non-Islamic countries. Different surveys and official reports provide varying numbers. Muslim countries have a greater percentage of young population and the young population is tech-savvy and therefore adopt more technological tools and use mobile devices for accessing different services. The number of Muslims in Western countries is an unsure number, and no exact percentage of Muslims have been reported yet in non-Islamic countries. The rapid population explosion of Muslims can be attributed to the high fertility rate of Muslims. The following list is modified from the PWC report on the religious landscape. 276

H A L A L F O O D AU D I T A N D C E RT I F I C AT I O N

Table 19.2 Population and Technology Adoption in OIC Countries Country

Total Population in Million

Internet Users in Millions

Active Social Mobile Media Users Subscriptions

Active Mobile Social Users

Afghanistan Albania Algeria Azerbaijan Bahrain Bangladesh Brunei Darussalam Egypt Ethiopia Gambia Ghana Guinea Guinea-Bissau Indonesia Iran Iraq Jordan Kazakhstan Kosovo Kuwait Kyrgyzstan Lebanon Libya Malaysia Maldives Mali Mauritania Mayotte Morocco Niger Oman Pakistan Palestine Qatar Saudi Arabia Senegal Somalia Sudan Syria Tajikistan Tunisia Turkey Turkmenistan UAE Uzbekistan Yemen

35.95 2.93 41.66 9.88 1.53 165.5 431.4

4.01 1.95 21 7.9 1.5 81.7 410

3.5 1.5 21 2.7 1.4 30 410

3.2 1.3 19 1.8 1.1 28 350

27.66 4.72 49.7 11.28 3.5 137.2 534.4

98.46 49.23 39 100.08 106.2 16.4 3.8 53.3 2.13 0.39 0.34 3.36 29.15 10.11 5.6 34.57 12.88 1.6 1.6 11.46 1.88 0.12 0.12 1.39 265.4 132.7 130 415.7 81.59 56.7 40 125.87 38.81 19 19 36.33 9.8 8.7 5.8 11.34 18.3 14.06 5.8 26.39 1.78 1.52 1.1 1.94 4.17 4.1 4.1 7.4 6.09 2.11 1.3 7.91 6.09 5.54 4 4.56 6.42 3.8 3.8 10.94 31.83 25.08 24 42.25 440.3 340 340 829.9 18.82 12.4 1.7 20.78 4.48 0.81 0.67 5.07 256.4 thousand 107.9 thousand 81 thousand 236.6 thousand 35.97 22.56 16 42.35 21.89 0.95 0.48 9.47 4.73 3.31 2.6 7.07 198.9 44.6 35 147.5 4.99 3.05 1.6 3.78 2.67 2.64 2.64 4.67 33.25 30.25 25 56.8 16.07 9.74 3.1 15.68 14.96 1.2 1.2 6.11 41.02 11.81 2.8 29.88 18.28 6.03 5.5 14.24 9.01 3 0.31 9.69 11.6 7.89 7.2 17.26 81.33 54.33 51 72.9 5.8 1.04 0.03 2.98 9.47 9.38 9.38 19.18 32.14 15.45 1.3 22.65 28.58 7.03 2.3 18.37

Source: We are Social, Digital Year Book (2018).

277

35 3.6 0.31 4.9 1.5 0.11 120 40 17 5.3 2.5 0.91 3.1 0.65 3.6 3.5 22 320 1.5 0.61 71 thousand 15 0.44 2 32 1.4 2.3 18 2.9 1.1 2.6

H adia S aqib H ashmi and H assnian A li

Table 19.3 Number of Muslims in Western Countries Country

Number of Muslims 2010

% in 2010

Number of Muslims 2030

% in 2030

France Germany United Kingdom United States Italy Spain Canada Netherlands Belgium Australia Russia

4,704,000.00 4,119,000.00 2,869,000.00 2,595,000.00 1,583,000.00 1,021,000.00 940,000.00 914,000.00 638,000.00 399,000.00 16,379,000.00

7.5 5.1 4.6 0.8 2.6 2.3 2.8 5.5 6.1 1.9 11.7

6,860,000.00 5,545,000.00 5,567,000.00 6,216,000.00 3,199,000.00 1,859,000.00 2,661,000.00 1,365,000.00 1,149,000.00 714,000.00 18,556,000.00

10.3 7.1 8.2 1.7 5.4 3.7 6.6 7.8 10.2 2.8 14.4

Source: PWC Research (2010).

19.1.3 Halal audit and certification The global spectrum in the trend of adoption and awareness of the halal concept among Muslim consumers largely varies. At one end, in Muslimmajority countries, most consumers assume that everything is credibly halal despite many brands selling non-halal food items. On the other hand, in non-Muslim-majority markets, the consumers, especially Muslims, insist on halal verification and certification. Halal certification started in Malaysia only in the 1980s. Since the beginning of the 1980s to date, it has expanded to more than forty countries including Muslim countries such as Pakistan and Brunei and non-Muslim countries, such as the UK, Japan, Thailand, the Philippines, Sri Lanka, Brazil, and Australia. This development in halal certification shows the demand and growth of halal products and services around the globe. Asian countries such as Malaysia and Indonesia tapped earlier into the race and have already taken initiatives such as the development of halal standards, traceability systems, and halal science centers (Khan & Haleem, 2016). According to a report published by the Department of Islamic Development Malaysia, there are more than sixty halal-certified bodies working in more than forty countries. These certified bodies act as supervisory bodies that make sure the whole process of manufacturing, farming, slaughtering, storing, and packaging to final supply at sale point at retailers’ and wholesalers’ is halal. After analyzing the whole process of the product providers, these certification bodies declare brands as halal-certified if the products and processes fulfill the criteria of standards set by the related countrycertified halal-regulatory body (Noordin et al., 2009). Due to globalization and e-commerce, multinational companies (MNCs) are also tapping into the global halal industry (Lever & Miele, 2012). These MNCs are very keen to get halal certification for their brands to 278

H A L A L F O O D AU D I T A N D C E RT I F I C AT I O N

attract the Muslim population, which is the 20% of global population and it is expected to increase to 30% by 2025. Halal certification assures all Muslim consumers that the product is in compliance with the shari’ah law, and for non-Muslims that the halal products are quality products based on halal and tayyab (Halal and wholesome) concepts that integrate the good manufacturing practices (GMP) and Hazard Analysis and Critical Control Points (HACCP). Halal certification bodies are also responsible for the exhaustive testing and analysis of both processes and products to confirm that the rigorous halal standards mandated for producers and manufacturers have been met (World Halal Certification Bureau).1 Halal food certification process approves whether the food is halal or haram after an audit conducted under the halal food standards of the country. The audit is performed by a person who is technically competent in auditing halal procedures and requirements in a particular food processing technology or field, formally appointed by a halal certification body or halal food authority. The halal auditor, according to his prewritten compliance checklist, inspects whether production activities and operations in a factory or a shop meet the halal-certification and halal-label Table 19.4 Number of Certification Bodies in the World Country

Number of Bodies

Country

Number of Bodies

Australia Austria Argentina Bangladesh Belgium Bosnia Brazil Brunei Canada China Chile Croatia Egypt France Germany India Indonesia Iran Ireland Italy Japan Kazakhstan Kenya

6 1 1 1 1 1 2 1 2 5 1 1 1 1 1 3 1 1 1 2 7 2 1

Lithuania Maldives Morocco Netherlands/Holland New Zealand Pakistan Philippines Poland Singapore South Africa South Korea Spain Sri Lanka Switzerland Taiwan Thailand Turkey Ukraine UAE United Kingdom USA Vietnam Lithuania

1 1 1 3 2 2 3 2 1 3 1 1 1 1 1 1 2 1 1 2 2 1 1

Source: http://www.halal.gov.my/v4/ckfinder/userfiles/files/cb2/LATEST%20CB%20LIST%2 0-%20AS%20OF%20FEBRUARY%2013TH%202019.pdf.

279

H adia S aqib H ashmi and H assnian A li

Applications

Facility Audit Review Meeting Process Recommendation

*Halal Program *Process Review *Ingredient Review *Physical Audit

Ingredient Replacement Approval of Facility

Product Review

Process Review

Production

Batch Process

Records to the Agency

Total Process Yearly Certificates

Verify Records Batch Certificate Issue

Figure 19.1 Process of Halal Certification. Source: Modified from Riaz (2018).

requirements or not. The halal-certification process begins with the selection of an organization that meets the company’s needs for the markets to be served. If the target is a specific country, it is best to use an organization that is approved, recognized, or acceptable in that country. If the market areas are broader or even global, then an organization with an international scope would better meet the company’s needs (Shafie & Othman, 2006). • •

Filling out an application to the certification organization on paper or on the Internet. Review of the information by the organization, especially the type of product and its components. 280

H A L A L F O O D AU D I T A N D C E RT I F I C AT I O N

• • • • •

Inspection and approval of the facility. This includes a review of the production equipment, inspection of ingredients, cleaning procedures, sanitation, and potential for cross-contamination. For slaughterhouses, inspection involves a review of the holding areas, method of stunning, actual slaying, pre- and post-slaughter-handling, etc. Determining the cost and fees involved and signing of the contract. (Note: The contract normally includes the responsibility of both parties to maintain confidentiality.) Payment of fees and expenses. Issuance of the halal certificate (Riaz, 2018). 19.1.4 Educating the youth on halal food audit and certification

Young people are seen as a major resource of any country and society. They bring in energy, enthusiasm, and new ideas. They also set new trends in lifestyles, customs, and culinary habits. For the past several decades, the global Muslim population has consistently been youthful (Fischer, 2011). The halal logo on a product affirms the consumer that it is certified halal in accordance with Islamic law. This confirmation provides the Muslim consumer peace of mind and inner satisfaction. The halal logo matters a lot for a Muslim consumer because selection and usage of a halal product is a religious obligation and commandment from the Lawgiver. The halal logo stamped on a product is a kind of promise from the manufacturer and brand owner that the product is halal-certified and has no haram ingredients or has not been through haram processes (Iberahim et al., 2012). The consumption of halal food is a religious obligation for Muslims; hence, it is imperative for every Muslim to be aware of halal and haram. In this dynamic world, the processes are becoming complex and their understanding requires more than basic knowledge, which means the knowledge of different procedures, processes, and functions. This becomes more important when it comes to the manufacturing and production of food items as it not only is a religious obligation, it entails a social obligation as well because it directly impacts people’s health. Hence, it is the duty of Muslim states, especially to provide a learning environment for the young and it is also upon academia to deliver knowledge, which is important for young consumers. 19.1.5 Challenges Though the global halal industry is growing, the industry is also facing some challenges. These challenges are almost common in all the segments of the halal industry except Islamic finance due to its different nature from other segments. Amidst that, there are challenges that are linked to the education on halal audit and certification processes and the ways of its provision to the youth. 281

H adia S aqib H ashmi and H assnian A li

19.1.6 Lack of academic programs on the halal food industry There is a current phenomenon and a reality that the Islamic banking and finance industry has gained attraction at the global level. The global landscape of Islamic banking has been increasing and so has its asset size. Governments, regulators, corporations, businesses, researchers, and academia all have paid much attention to the Islamic banking and finance industry. This trend is common in all the countries with the exception of very few. The dilemma is that the same level of attention has not been paid to the other segments of the halal industry or halal economy (Jais, 2014). Relevant to our discussion on the challenge of education on halal food, there are very limited number of institutions that are providing mainstream education on halal food and its related areas. The following list provides the name of institutions offering some programs related to the halal industry. This number is very small and one wonders whether these institutions or even the available programs are enough in catering to the needs of the halal industry. The reason behind fewer academic programs is a common misperception among academia that halal food or other segments are covered in the curricula of Islamic finance. A plethora of studies have claimed that among the major challenges that the global halal industry has been facing is the lack of a skilled and knowledgeable workforce (Alina et al., 2013; Bergeaud-Blackler et al., 2015; Elasrag, 2016). On correlating the aforementioned two points, it is clear that the main reason behind not having sufficient number of skilled and knowledgeable people as halal workforce is because fewer institutions offer a very limited number of courses. For halal certification, in addition to the authorities in different countries, such as Malaysia and Pakistan, there must be competent and certified halal executives and committee members. This creates a tremendous need for halal education. Educational institutions in Islamic countries have a role to play; they have to start and launch the degree’s program and specialization in halal education exclusively. Government authorities have to add educational content related to halal food audit and certification to the primary grade curriculum, middle, matriculation, and higher, until specialization. E-learning could be an alternative to compensate and improve the learning and skills of staff and professionals of the global halal industry. There are some platforms that provide and offer e-learning courses about halal education and halal training for the students, staff, and professionals of the global halal industry. These platforms should revisit their e-learning courses and need to redesign them under the supervision of experts from academia and industry to fulfill the need of a highly skilled workforce in the global halal industry. 19.1.7 Lack of training of staff at the workplace Training is defined as an organized and systematic way of affecting and influencing individuals’ knowledge and skills, the improvement of which can 282

H A L A L F O O D AU D I T A N D C E RT I F I C AT I O N

Table 19.5 Educational Programs Related to Halal Industry at Different Institutions Course Name

Organization

Level

Halal Advanced Professional Chef Course Executive Diploma on Halal Industry

Chef Academy London, London Halal Research Council

Halal Training

Professional course Executive diploma online (DL) Training

The Department of Halal Certification EU (DHCE) Crescent Rating Academy Diploma

Chef Training & Accreditation Program Specialized Halal Gourmet Competency Training & Accreditation for Chefs Halal Food Professional Halal Training Program (Halal Executive) Professional Halal Training Program (Halal Executive) Professional Certification In Halal Executive Program Halal Food Safety Management System (HFSMS) Training program PGD Halal Industry Program

Open learning The International Islamic University Malaysia (IIUM) Jakim Accredited Training Provider 3D Educators – Trainers & Consultants

Amanah Halal Research Center Professional Certification in Halal Product Research Halal Executive Course Institute (HPRI) University Putra Malaysia Halal Management, Shariah and Universiti Islam Sultan Halal Laws, Science and Halal Sharif Ali, UNISSA, Product Innovation Brunei Darussalam Diploma in Halal Management University Technology Mara, UiTM, Malaysia Halal Management University Sains Islam Malaysia, USIM, Malaysia Halal Executives Diploma Kolej Universiti Islam Melaka (KUIM)

Training Executive diploma Master degree Training program Online diploma (DL) Online (DL) Executive course BS/Master/PhD degrees 6 months diploma Short courses 5 days, 7 days, 3 months 6 months

Source: Websites of the organizations.

lead to a good team and finally result in the enhancement of an organization’s effectiveness (Pahim et al., 2012b). In an organization, business, or in an industry, talented, skilled, and trained workforce play a significant role in boosting the performance of that organization, business, and industry. Research shows that there is a positive relationship between the training of employees and staff and their performance within an organization (Pahim 283

H adia S aqib H ashmi and H assnian A li

et  al., 2012a). In the present competitive market, industries and organizations see each other as rivals. So, the trained and skilled workforce keep the organization in the competition with the assurance that the organization is sustainable. Training is important for all types of organizations and workforce in every industry. It is very important that an emerging industry recruits skilled and trained workforce. The global halal industry is emerging and growing at an exponential rate. All industries must follow conventional regulations mandated by the authorities. The halal industry subscribes to Islamic laws of halal and haram that set it apart from other industries. So, training employees and workforce on halal and haram is crucial (Hashim & Shariff, 2016). The players in the global halal industry must be aware of the importance of halal training. Providing employees and staff with adequate halal training is indispensable to remain competitive. Consumers are likely to trust an organization that ensures that its staff are halal-trained. Due to halal training, the staff can improve their skills and they may also prove to be very efficient at the workplace (Tarmizi et al., 2014). Many conventional food and beverages and tourism agencies, companies, and associations also offer halal food and beverages, and other facilities like halal tourism attract young Muslim consumers and travelers. It is mandatory that these agencies, companies, and associations employ adequately halal-trained staff. As conventional firms understand the value of halal training, they have also started training their staff on all things halal (Battour & Ismail, 2016). Halal training is also important for the workforce in the halal industry in terms of them being sure whether products and services are of halal or haram origin. The halal logo authenticates products and ensures the satisfaction of Muslim consumers. In conformity with the shari’ah, the halal processes and practices are directly linked to Islamic teachings, beliefs, and sentiments. It is therefore imperative that the workforce of the global halal industry have adequate and proper halal training. 19.1.8 Manipulation of the halal logo by manufacturers Manufacturers are almost always interested in gaining the trust of new customers and generating more profit as well. The decision of customers in the selection of a product from a manufacturer depends upon the quality, price, branding of the products, and in the case of food, the taste as well, the packaging, and origin of products. According to Maison et al. (2018), the halal logo or label has a tremendous influence on the decision-making skills of Muslim consumers in both Muslim and non-Muslim countries. At times, some manufacturers can, and do, manipulate this behavior of Muslim consumers by using the halal label on non-halal products. Much evidence of scandals, involving the adulteration of halal products and the misuse of the halal label on meat sold by some famous brands in Europe and some 284

H A L A L F O O D AU D I T A N D C E RT I F I C AT I O N

Muslim countries, has created serious hurdles for halal certification bodies and halal auditing and supervisory authorities (Ali et al., 2013). The denial of halal standards by manufacturers leaves a great impact on the satisfaction level of Muslim consumers and indirectly hampers the growth of the industry as well. Young consumers do care about their beliefs and when they encounter scandals about the misuse of the halal logo, which directly hurts their religious sentiments, they start raising concerns over the performance and authenticity of halal certification bodies. 19.1.9 The lack of collaboration and interoperability among halal certification bodies The lack of collaboration among the world’s halal certification bodies and authorities has created “doubts” in the minds of Muslim consumers on the authenticity of the halal certification process. Lack of formalized halal guidelines is one of the major issues and acts as a constant threat to the halal industry including halal logistics. The absence of a worldwide halal certification such as a universal halal logo will result in greater difficulties in keeping up halal integrity throughout the supply chain. Momentarily, there are more than 60 halal certifying bodies comprising governments, government agencies, non-governmental organizations, local mosques, or Islamic societies (Hudaefi & Jaswir, 2019) that have claimed that the issues related with halal packaging are halal certification on the packaging, handling methods of halal products, and packaging traceability. Halal logo on the packaging is important since it not only imports that the product is halal, but it also indicates that the product is safe, clean, and not harmful or haram for consumption. Standardization of the laws, principles, and regulation of halal certification is closely related to the education on halal food audit and certification, in the sense that, in the absence of uniformity, it would be difficult for a learner or student of halal certification to understand all the principles and regulations that are implemented in different countries. In contrast, in the presence of uniform standards, it would be easier for students, teachers, researchers, even industry personnel to gain a better understanding of halal standards (Halim & Salleh, 2012). 19.1.10 Limited knowledgeable workforce in the halal industry One of the crucial problems that could hamper the growth of the halal industry is the shortage of manpower and skilled workers. The duns numbers for halal products are very high and keep on increasing day by day, but the number of halal-certified companies or companies applying for halal certification is relatively less than the whole market share. The demand for capable halal workforce has doubled, so these changes require 285

H adia S aqib H ashmi and H assnian A li

a well-informed halal workforce. Training and educating people on halal take time. Drastic changes have devastated the supply side of the workforce by the sudden demands for halal-competent personnel, which has resulted in the need for urgent technical expertise. Khan (2011) enumerates that “the major challenge faced by the halal industry in different countries including Malaysia is the shortage of knowledgeable workforce that understands the Shariah requirements and implementing Shariah knowledge into actual industrial practice”. Further, there are very few accomplished halal consultants, and their skills and aptitudes of others who call themselves halal personnel are questionable due to inadequate standard criteria. However, the human capital in Malaysia is ready for the halal industry’s rapid expansion, specifically the management, executives, the active workforce in manufacturing and services companies, halal authorities and agencies, establishments of higher learning in implementing halal and shari’ah principles for halal businesses, services, and industries (Syazwan Ab Talib & Bakar Abdul Hamid, 2014). The halal industry in Malaysia wants halal-certified operations managers to be readily available for the job market with knowledge in shari’ah and Islamic principles appertaining to halal management and to possess technical business knowledge in managing sourcing, production, and manufacturing, products and services, purchasing, store, and inventory and those who are pertinent in business and operations (Majid et al., 2015). Even so, in positing evidence on the lack of awareness on halal concepts and compassionate choice of the ingredients, sources, processing, and storage between halal players in Malaysia, and on even recreating awareness on the halal way of life among Muslims, Malaysians were relatively less aware as compared with Thailand and Indonesia due to a lack of knowledge and information on the halal logo and halal administrative matters. Some researchers also shared the same findings, adding to the debilitation on the implementation of halal certification and logo and the lack of attitude and sensitivity based on the Halal Sensitivity Index (Othman et al., 2017).

19.2 Future prospects 19.2.1 Halal education for consumers Halal education is the need of the hour to help people understand the meaning of all things halal. Halal today is not merely a religious obligation. Along with Muslims, non-Muslims also appear to prefer halal products for their health, cleanliness, and good-quality benefits (Mathew et al., 2014). As the Muslim majority has been rapidly increasing, Muslim culture has been globalized. Therefore, halal education is very necessary for both Muslims and non-Muslims.

286

H A L A L F O O D AU D I T A N D C E RT I F I C AT I O N

19.2.2 For Muslim consumers Every Muslim should be aware of the basic rules and teachings of the Prophet on halal and haram. Conflicts over halal food and certification logo due to contamination with haram content have been on the rise. A Muslim must know the processes involving halal certification and logo, which will develop a sense of investigation about the product. Finding halal products in Muslim countries is easy; when it comes to Muslim-minority countries, a Muslim must carefully and keenly check the ingredients and halal logo stamped on food packets (Jais, 2014). Consumers, producers, and sellers must have proper knowledge of what products come under the category of halal food. They should be provided with the knowledge that halal is not limited to only animal meat and the slaughtering process, but it covers all food items and their production, processing, and selling procedures, confirming their hygiene status. All additives and enzymes are listed under ingredients of the label ‘halal food’. Halal education is imperative to all Muslim consumers (Abdul Rahim et al., 2013). 19.2.3 For non-Muslim consumers Halal food has been gaining popularity among non-Muslim consumers for its health, cleanliness, and good-quality benefits. When animals are slaughtered the halal way by subscribing to a basic teaching of Islam, it can inspire non-Muslims to eat halal food. A specially designed content or program should be available for non-Muslims to educate them on halal values. The health benefits of consuming halal food should be revealed to non-Muslims. They must know Islam teaches and emphasizes upon cleanliness of food preparation and production. Islam also emphasizes on the personal hygiene of individuals ensuring proper cleanliness in food processing. Halal education to non-Muslims can inspire them to consume halal food products, which will leave a very positive impact on the halal industry, resulting in its sustainability and exponential growth.

19.3 Halal education for the workforce in the halal industry The exponential growth in the halal industry demands more skilled, educated, and trained personnel as workforce. Halal education for employees ought to be the primary sustainability goal of the global halal industry.

19.4 Halal education for halal consultants and auditors Knowledge is the most important weapon of the 21st century for wealth creation, which demands continuous learning (Zulfakar et al., 2014). Some

287

H adia S aqib H ashmi and H assnian A li

universities and research studies have initiated halal studies but they are deficient in specifically designed curriculum. The halal industry is facing serious shortage of halal auditors to fill the workforce gap for better and improved working. The impediment to creating a halal assurance system is the lack of competent auditors who are equipped with the scientific knowledge of halal and shari’ah requirements. The halal industry has recorded an exponential growth, which has been generating a similar quantum of job opportunities as well. The human capital that is desired can be prepared by adding properly designed courses and programs with enriched curriculum in mainstream education. The jobs are many but the gap is not being filled due to unskilled human capital, which is also essential for the sustainability of the halal food industry (Nik Muhammad et al., 2009; Shariff et al., 2013). The present workforce has gained a lot of technical work experience but they need to provide shari’ah knowledge as well. Non-Muslims in multiracial countries can choose to be trained in halal studies like Muslims (Abdul Rahim et al., 2013). 19.4.1 Halal education on halal logistics and supply chain The halal logistics and supply chain (HLSC) includes all the steps from the farm to fork (until the food reaches the dining table of the customer). It includes production, processing/manufacturing, packaging, storage, and transportation until it reaches the retail spot. To support the HLSC, the entire workforce shall be trained on the shari’ah-based requirements. The content ought to be in accordance with the upgraded standards (Ab Talib et  al., 2015; Fischer, 2016; Hashim & Shariff, 2016; Syazwan Ab Talib & Bakar Abdul Hamid, 2014). Halal education should be taught and emphasized very early on and continuously throughout one’s years of education and not merely be a focus at the tertiary level. Table 19.6 Halal Education for Halal Logistics and Supply Chain Primary

Secondary

Consumers: Muslims Non-Muslims Basic knowledge on halal and haram Benefits of halal Importance of halal certification logo

Post-secondary

Tertiary

Workforce of halal industry: Halal food scientists and Halal food supply chains Undergraduate degree Post graduate degree Doctorate degree Short courses Diplomas Post graduate diplomas

288

H A L A L F O O D AU D I T A N D C E RT I F I C AT I O N

19.5 Job areas/opportunities for halal professionals • • • • • • • • • • • • • • •

Executive halal Supervisor halal Slaughterhouse worker Halal meat checker Internal halal auditors External halal auditors Trainers in halal timings Halal consultants Researchers on halal research Halal enforcement Halal analyst Shari’ah board Halal trade facilitator Media on halal news/information Subject matter expert on all things halal

19.6 Conclusion The Muslim population around the world has been rapidly increasing, thus resulting in the expansion of the halal food industry as well. A majority of the Muslims are young and they comprise both the consumers of halal products and the workforce in the halal industry. Special strategies to create awareness and develop professional halal industry skills via halal education among the young generation are imperative. For the young consumers, whether they are Muslims or non-Muslims, the curriculum should be incorporated into mainstream education. In addition to the shari’ah teachings on consuming the halal way, the health benefits of such consumption and the halal way of living should be taught. The need of human capital for the halal industry can be catered to by preparing a proper curriculum for halal education beginning from primary and secondary education level up to territory education level because holding halal training for creating halal executives serves only as a short-term measure to meet the present halal job demand/ market, but long-term and systematic human capital development strategies are essential to educate, train, and develop the present halal executives to be well versed with the real industry practices and business environment. Hence, a series of structured and approved halal training and continuous professional development (CPD) training in halal management are required to become qualified human capital for the halal industry.

Note 1 https://worldhalalcb.com.au/.

289

H adia S aqib H ashmi and H assnian A li

References Ab Talib, M. S., Abdul Hamid, A. B., & Zulfakar, M. H. (2015). Halal supply chain critical success factors: a literature review. Journal of Islamic Marketing, 6(1), 44–71. Abdul Rahim, N., Rahim, A., Syamsul, H., Mashitoh, A., & Yusop, M. (2013). The academia’s multidisciplinary approaches in providing education, scientific training and services to the Malaysian halal industry. 13, 79–84. https://doi.org/10.5829/ idosi.mejsr.2013.16.s.100213. Abdullah, S. (2012). Risk management via Takaful from a perspective of Maqasid of Shariah. Procedia – Social and Behavioral Sciences, 65, 535–541. https://doi. org/10.1016/j.sbspro.2012.11.161. Abubakar, Y. (2016). Corporate social responsibility of islamic financial institutions: a look from the Maqasid Al-Shariah (purpose of Shariah) approach. Business and Economics Journal, 7, 1–4. https://doi.org/10.4172/2151-6219.1000255. AFP Fact Check. (2019, December 3). Islam is second to Christianity in estimates of world religions with the most followers. AFP Fact Check. https://factcheck.afp. com/islam-second-christianity-estimates-world-religions-most-followers. Ali, M. H., Tan, K. H., & Makhbul, Z. M. (2013). Mitigating halal food integrity risk through supply chain integration. Asia Pacific Industrial Engineering and Management System, 44, 0–9. Alina, A. R., Norhayati Rafida, A. R., Syamsul, H., Siti Mashitoh, A., & Yusop, M. H. M. (2013). The academia’s multidisciplinary approaches in providing education, scientific training and services to the Malaysian halal industry. Middle-East Journal of Scientific Research, 13, 79–84. Battour, M., & Ismail, M. N. (2016). Halal tourism: concepts, practices, challenges and future. Tourism Management Perspectives, 19, 150–154. Bergeaud-Blackler, F., Fischer, J., & Lever, J. (2015). Halal Matters: Islam, Politics and Markets in Global Perspective. Routledge: Taylor and Francis. Businessdictionary.com. (2017). Consumer. Online: http://BusinessDictionary.com/ consumer Dusuki, A. W., & Abozaid, A. (2007). A Critical Appraisal on the Challenges of Realizing Maqasid Al-Shariaah in Islamic Banking and Finance. International Journal of Economics, Management and Accounting, 15(2). https://journals.iium. edu.my/enmjournal/index.php/enmj/article/view/133. Elasrag, H. (2016). Halal industry: key challenges and opportunities. Available at SSRN 2735417. Emont, J. (2016). Why the world’s Muslim population is growing so very, very quickly. Washington Post. https://www.washingtonpost.com/news/worldviews/ wp/2016/09/09/where-and-why-the-median-age-for-muslims-is-so-low/. Fischer, J. (2011). The halal frontier. In The Halal Frontier (Chapter 1 pp. 1–30). New York: Palgrave Macmillan. Fischer, J. (2016). Manufacturing halal in Malaysia. Contemporary Islam, 10(1), 35–52. Halim, M. A., & Salleh, M. M. M. (2012). The possibility of uniformity on halal standards in organization of Islamic countries (OIC) country. World Applied Sciences Journal, 17(17), 6–10. Hashim, H. I. C., & Shariff, S. M. M. (2016). Halal supply chain management training: issues and challenges. Procedia Economics and Finance, 37, 33–38.

290

H A L A L F O O D AU D I T A N D C E RT I F I C AT I O N

Henderson, J. C. (2016). Halal food, certification and halal tourism: insights from Malaysia and Singapore. Tourism Management Perspectives, 19, 160–164. Hudaefi, F. A., & Jaswir, I. (2019). Halal governance in Indonesia: theory, current practices, and related issues. Journal of Islamic Monetary Economics and Finance, 5(1), 89–116. Iberahim, H., Kamaruddin, R., & Shabudin, A. (2012). Halal development system: the institutional framework, issues and challenges for halal logistics. 2012 IEEE Symposium on Business, Engineering and Industrial Applications, 760–765, Bandung, Indonesia. Jais, A. (2014). Halal in Mainstream Education: Where Are We Now and What the Future Holds for Halal Education? https://doi.org/10.13140/RG.2.1.4788.5041. Jamaludin, M. A., Kamarudin, N. K. H., & Ramli, M. A. (2015). Halal executive’s perception towards Halal training programme based on training needs analysis. The International Journal of Humanities and Social Studies, 3(1), 1–10. Khan, M. (2011). Transformasi Industri Halal. Dewan Bahasa dan Pustaka: Dewan Ekonomi, 3–5. Khan, M. I., & Haleem, A. (2016). Understanding “halal” and “halal certification & accreditation system” – A Brief Review. Saudi Journal of Business and Management Studies, 1(1), 32–42. Kunhibava, S., & Rachagan, S. (2011). Shariah and law in relation to Islamic banking and finance. Banking and Finance Law Review, 26(3), 544–557. Laldin, D. M. A. (2006). Introduction to Shariah and Islamic Jurisprudence. Ampang: Cert Publications Sdn Bhd. Lever, J., & Miele, M. (2012). The growth of halal meat markets in Europe: an exploration of the supply side theory of religion. Journal of Rural Studies, 28(4), 528–537. Maison, D., Marchlewska, M., Syarifah, D., Zein, R. A., & Purba, H. P. (2018). Explicit versus implicit “halal” information: influence of the halal label and the country-of-origin information on product perceptions in Indonesia. Frontiers in Psychology, 9, 382. Majid, M. A. A., Abidin, I. H. Z., Majid, H., & Chik, C. T. (2015). Issues of halal food implementation in Malaysia. Journal of Applied Environmental and Biological Sciences, 5(6), 50–56. Mathew, V., Abdullah, A., & Ismail, S. (2014). Acceptance on halal food among Non-Muslim consumers. Procedia – Social and Behavioral Sciences, 121, 262–271. https://doi.org/10.1016/j.sbspro.2014.01.1127. Musa, M., & Saifuddeen, M. (Eds.). (2005). Quality Standard: From the Islamic Perspective. Kuala Lumpur: Institut Kefahaman Islam Malaysia, xxi, 229: ill.; 24 cm. Nik Muhammad, N. M., Isa, F., & Kifli, B. (2009). Positioning Malaysia as halalhub: integration role of supply chain strategy and halal assurance system. Asian Social Science, 5. https://doi.org/10.5539/ass.v5n7p44. Noordin, N., Noor, N. L. M., Hashim, M., & Samicho, Z. (2009). Value chain of halal certification system: a case of the Malaysia halal industry. European and Mediterranean Conference on Information Systems, 1–14, The British University in Dubai, UAE. Othman, B., Md. Shaarani, S., & Bahron, A. (2017). The influence of knowledge, attitude and sensitivity to government policies in halal certification process on organizational performance. Journal of Islamic Marketing, 8(3), 393–408.

291

H adia S aqib H ashmi and H assnian A li

Othman, K. (2017). Quality management system vs. Maqasid Shariah Islamic quality management system vs. customer satisfaction. International Journal of Academic Research in Business and Social Sciences, 7, 20–34. https://doi.org/10.6007/ IJARBSS/v7-i13/3182. Othman, K., Md. Hamdani, S., Sulaiman, M., Mutalib, M., & Mohd Ramly, R. (2018). Education as Moderator to Knowledge Consumers in Creating Awareness of Halal Food Consumption. In Proceedings of Knowledge Management International Conference (Kmice), 318–323. University of Utara Malaysia Press. Oxford University Press (2017), Consumer. The Oxford English Dictionary. Oxford: Clarendon Press. Pahim, K. M. B., Jemali, S., & Mohamad, S. J. A. N. S. (2012a). An empirical research on relationship between demand, people and awareness towards training needs: a case study in Malaysia halal logistics industry. 2012 IEEE Business, Engineering & Industrial Applications Colloquium (BEIAC), 246–251, Kuala Lumpur, Malaysia. Pahim, K. M. B., Jemali, S., & Mohamad, S. J. A. N. S. (2012b). Notice of retraction the importance of training for halal logistics industry in Malaysia. 2012 IEEE Symposium on Humanities, Science and Engineering Research, 1635–1640, Kuala Lumpur, Malaysia. Rafikov, I., & Saiti, B. (2017). An analysis of financial speculation: from the Maqasid Al-Shari’ah perspective. Humanomics, 33, 2–14. https://doi.org/10.1108/ H-10-2016-0077. Rahman, F., Tareq, M., Ayu Yunanda, R., & Mahdzir, A. (2017). Maqasid AlShari’ah-based performance measurement for halal industry. Humanomics, 33. https://doi.org/10.1108/H-03-2017-0054. Rahman I. Doi, A. (2008). Shari’ah: The Islamic Law. London: Ta-Ha Publishers Ltd. Riaz, M. (2018). Handbook of Halal Food Production. https://doi.org/10.1201/ 9781315119564. Shafie, S., & Othman, M. N. (2006). Halal certification: an international marketing issues and challenges. Proceeding at the International IFSAM VIIIth World Congress, 28–30. Kuala Lumpur: University of Malaya Press. Shariff, S. M., Johan, Z. J., & Jamil, N. A. (2013). Assessment of project management skills and learning outcomes in students’ projects. Procedia – Social and Behavioral Sciences, 90, 745–754. https://doi.org/10.1016/j.sbspro.2013.07.148. SME Annual Report. (2006). http://www.bnm.gov.my/index.php?ch=en_press&pg= en_press&ac=676&lang=en. Syazwan Ab Talib, M., & Bakar Abdul Hamid, A. (2014). Halal logistics in Malaysia: a SWOT analysis. Journal of Islamic Marketing, 5(3), 322–343. Tarmizi, H. A., Kamarulzaman, N. H., Latiff, I. A., & Rahman, A. A. (2014). Factors influencing readiness towards halal logistics among food-based logistics players in Malaysia. UMK Procedia, 1, 42–49. The Global Islamic Economy Indicator (GIEI). (2017, 2018). https://www. salaamgateway.com/en/story/the_global_islamic_economy_indicator_gieiSALAAM28042018224521/. Thomson Reuters, & Dinar Standard. (2018). State of the Global Islamic Economy Report 2018/2019. Zulfakar, M. H., Anuar, M. M., & Talib, M. S. A. (2014). Conceptual framework on halal food supply chain integrity enhancement. Procedia – Social and Behavioral Sciences, 121, 58–67. https://doi.org/10.1016/j.sbspro.2014.01.1108.

292

20 OPTIMIZING HALAL TOURISM IN INDONESIA TO ACCELERATE ECONOMIC GROWTH Shinta Maharani 20.1 Introduction Indonesia has more than 17,000 islands extending between the Pacific and Indian Oceans, across 200 cultural societies, with about 300 spoken languages. The geographical position bridges the continents of Asia and Australia, and it makes Indonesia appear to be a land of endless spectacular wonder because this incredible country stretches along the line of equator, opening it to diversification and cultural expansion. It is both advantageous and challenging to focus on the development of the country as a sustainable world-class tourism destination. There has been no research trying to blend economic growth with halal tourism yet. A reform agenda for Indonesia would be highly advantageous to Jakarta. As an open, independent stretch beyond the city, Jakarta would be a trendsetter to the government of Indonesia as a halal tourism destination because it would be the fastest way to economic growth, resulting in revenue to the government from tourism, such as income from visa single entry, tourist tax, tourist accommodation and transportation, and money exchange. The aims of this chapter are (1) to describe the causal relationship between the vision of Indonesian tourism and innovation by the government, (2) to improve tourist experience through halal tourism, and (3) to analyze how halal tourism in Jakarta is the fastest way to economic growth.

Economic Growth

Sustainability of Halal Tourism Government Revenue

Figure 20.1  Framework.

DOI: 10.4324/9781003050209-20293

S hinta M aharani

20.2 Halal tourism According to the Global Muslim Travel Index 2017 by Crescent Rating, halal tourism growth was reported at USD220 billion in 2020. In 2008, Crescent Rating was started as the world’s first online hotel attribute tool committed to Muslim tourists. It has been established on the scope of comfort and services offered to Muslim guests, consisting of the use of prayer carpets, qibla direction, anti-alcohol policies, and availability of halal-certified food, with Crescent Rating’s rating scale of 1 through 7 for different categories. Battour and Ismail (2015) defined halal tourism as follows: Only all objects or actions that are considered acceptable according to Islamic guidance to be used or covered by Muslims in the tourism industry. This description views Islamic law (shari’ah) as the core principle for providing tourism services and products for consumers (in this case, Muslims), like halal hotels, halal resorts, halal restaurants, and halal trips. Six basic needs of Muslim tourists were identified in the Crescent Rating study of 130 countries, consisting of the following: 1 2 3 4 5 6

Halal food Prayer facilities Bathroom with water for ablution Service during the month of Ramadan Inclusion of non-halal labels (if there are foods that are not halal) Private facilities Factors Affecting the Decision of Muslim Tourist All Other Responses Air Travel Experience Air & Hotel Deal Dining Food Experience Adventure Choise of Destination Hotel/ resort Stay… Relaxation Muslim Friendly… Overall price Halal Food 0%

Factors Affecting the Decision of Muslim Tourist

20%

40%

60%

80%

Figure 20.2 Factors Affecting the Decision of Muslim Tourists. Source: Dinar Standard Crescent Rating, 2015.

294

OPTIMIZING HALAL TOURISM IN INDONESIA

Top 10 OIC Islamic Tourism Destinations Brunei Marocco Jordan Oman Indonesia

Top 10 OIC Islamic Tourism Destinations

Qatar Saudi Arabia UAE Turkey Malaysia 0

20

40

60

80

100

Figure 20.3 Halal Tourism Destinations.

The standard reference for halal tourism in the world, according to the Global Muslim Travel Index (GMTI), can be specified more or less as follows: 1

2

3

Family-friendly destinations, with indicators: a Family-friendly tourist destinations b Public safety for Muslim tourists c The many Muslim tourists visiting make it quite crowded Services and facilities in Muslim-friendly destinations, with indicators: a Choice of food and legal guarantee b Easy and good access to worship c Convenience at the airport is Muslim-friendly d Adequate accommodation options Halal awareness and destination marketing, with indicators: a Ease of connection b Reach and awareness of the needs of Muslim tourists c Connectivity of air transportation d Visa requirements

To fulfill these 11 indicators, a halal tourist destination must commit to the stakeholder and at the community level, in this case, to the government. The location must allow entry to all family members, parents, and children, with public security provided by the police, security guards, and staff.

295

S hinta M aharani

20.2.1 Prior study The researcher had conducted a preliminary research related to the optimization of halal tourism on 202 respondents from Indonesia. The research instrument used comprised 10 questionnaire statements. By using nonprobability sampling, the respondents were divided into two groups: the first group had 18 postgraduate students from the Magister of Sharia Economics and the second had 184 undergraduate students from the Faculty of Economics and Islamic Business at the State Institute of Islamic Studies Ponorogo (IAIN Ponorogo), assuming students are considered capable of practicing rational, critical, and visionary thinking toward the development of their beloved country. The results revealed that out of 202 respondents, 79.7% were female, while the remaining 20.3% were male. A surprising initial discovery revealed that the most popular hobby of 75% respondents was traveling and whose parental income was under 1 million rupiah, which is inversely proportional to the most popular hobby of 25% of respondents was reading and whose parental income was above 2 million rupiah. In addition to the descriptive statistical analysis, researchers also found that 80.7% of all respondents strongly agreed that tourism is both a want and a need. Of the questions posed on 10 items of the highest value, 90.3% responded that facilities are the most important in tourist destinations. On departing from the initial research, we concluded that every human being has a basic need to refresh his or her body and soul. Refreshing is necessary to restore energy and enthusiasm, as it is hoped that refreshing could freshen the mind and result in productive work. In addition to relieving fatigue, natural attractions are built with various facilities to gain income from tourists spending on accommodation, food, and goods to increase government revenue. Table 20.1 Halal Tourism in Indonesia (Prior Study, September 2018) No

Instrument

Classifications

Total

Percentages

1

Education

2

Gender

3

Hobby

4

Tourism

5

Destination

Postgraduate Undergraduate Female Male Traveling Reading Others Desire and need Desire Need Facility Sightseeing Food Others

18 184 161 41 151 40 11 162 24 16 184 10 6 2

8.9 91.1 79.7 20.3 75 20 5 80 12 8 91 5 3 1

Source: Shinta Maharani, primary data processed 2018.

296

OPTIMIZING HALAL TOURISM IN INDONESIA

Female Male

Figure 20.4 Respondents’ Gender.

Travelling Reading Others

Figure 20.5 Respondents’ Hobbies.

20.3 Methodology In this study, the data collection instruments used are the following. 20.3.1 Questionnaire The questionnaire is a technique of gathering information by asking written questions (Abdurrahman: 2003; 45). This technique was used to collect data on halal tourism. In this study, a Likert scale was used to measure attitudes, opinions, and perceptions of someone about an object or a particular phenomenon (Siregar: 2014; 50). 20.3.2 Documentation Documentation is intended to obtain data directly from research sites, including relevant books, regulations, activity reports, photographs, documentary films, and relevant data on research (Sugiyono: 2013; 137). This documentation is used as a supplement to obtain data as information material in the form of financial reports from the community through interviews.

20.4 Data analysis techniques 20.4.1 Correlation test 20.4.1.3 Simple correlation Correlation analysis or bivariate correlation was used to determine the relationship between two variables. The correlation coefficient obtained shows 297

S hinta M aharani

the closeness of the relationship between two variables (Duwi Prayitno: 2012; 59). The Pearson Product Moment Correlation is symbolized (r) by the condition that (r) is not more than the price (−1 ≤ r ≤ 1). If the value of r = −1, it means that the correlation is perfectly negative, and if r = 1, it means that the correlation is very strong (Hasan: 1999; 230–231). 20.4.2 Coefficient determination (R 2) The determination coefficient measures how far the model’s ability explains the variation of the dependent variable. The coefficient of determination aims to find out how much the ability of the independent variable explains the dependent variable in the percentage form. 20.4.3 Hypothesis test The hypothesis comes from the word ‘hypo’, which means below, and ‘thesis’, which means truth. The hypothesis is a temporary statement or just a suspicion of a research problem whose truth is still weak so it must be tested empirically (Hasan: 2006; 31). In this study, the hypothesis test used was a significance test jointly (F statistical test) and individual parameter significant test (t statistical test) (Sunyoto: 2012; 125). 20.4.3.1 Statistical test t The t-test to test the significance of the influence of individual independent variables on the dependent variable by considering other variables is constant. To draw conclusions expressed by looking at the significant value and comparing with the level of error (significance) used, i.e. if the probability value < alpha value (α), then the independent variable significantly influences the dependent variable. The basis for decision making is: Significant value > 0.05, then Ho is accepted and Ha is rejected. Significant value < 0.05, then Ho is rejected and Ha is accepted. 20.4.3.2 Statistical test F The F test is used to see the effect of the overall independent variables on the dependent variable and to see the effect by comparing the sig value with a value of 0.05 confidence level. If the sig value is smaller than the value of the degree of trust (sig < 0.05), it means that there is a significant relationship

298

OPTIMIZING HALAL TOURISM IN INDONESIA

between all independent variables on the dependent variable. We submit the following hypothesis: Ho: β1 = β2 = …. βn = 0, meaning that the independent variable simultaneously has no significant effect on the dependent variable. Ha has at least β1, which is ≠ 0, meaning that the independent variable has a significant effect on the dependent variable. The basis for conclusion follows: Significant value > 0.05 then Ho is accepted and Ha is rejected. Significant value < 0.05 then Ho is rejected and Ha is accepted. 20.4.3.3 Data mining techniques In this study the data mining instruments used were: Primary data were collected in the form of a questionnaire of written questions used as data regarding public perceptions/tourists’ perception of the halal tourism industry. Likert scale was useful for measuring a person’s perceptions, attitudes, and opinions about an object and/or particular phenomenon. Secondary data documentation was intended to obtain data directly from the research site, including, interviews, regulations, photographs, or data relevant to the research. This documentation is used as a supplement to obtain data as analysis material.

20.5 Result 20.5.1 The vision of the Ministry of Tourism Based on the Regulation of the Ministry of National Development Planning/ Head of the National Development Planning Agency No. 5 of 2014 concerning Guidelines for the Formulation and Analysis of the Strategic Plans of Ministries/Institutions (Rienstra K / L) 2015–2019, the vision is a general formulation of desired conditions at the end of the planning period. The intended planning period was 2018–2019. The Ministry of Tourism’s 2018–2019 vision was “Indonesia Becomes World Class Tourism Destination Country”, in which, the keyword is “vision of a world-class tourism destination country.” With the definition making Indonesia a world-class tourism destination country, one of the main choices of tourists is to travel to destinations that are supported by attractive places, easy accessibility, and quality amenities.

299

S hinta M aharani

20.5.2 The mission of the Ministry of Tourism Based on PPN Decree Number 5 of 2014 concerning Guidelines for the Compilation of Strategic Plans for Ministries/Institutions (Rienstra K / L) 2015–2019, the mission is a general formulation of the efforts carried out in realizing the vision. The accuracy in the formulation of the mission will determine the achievement of the vision. Based on the vision set by the Ministry of Tourism, the Ministry of Tourism’s mission was formulated, namely: 1 2 3 4 5

Develop world-class tourism destinations Doing marketing with tourist-oriented strategies Developing the environment and capacity of the highly competitive tourism industry Increasing the capacity and capability of national tourism institutions Increasing the professionalism of the Ministry of Tourism’s bureaucracy through bureaucratic reform of the Ministry of Tourism, the Republic of Indonesia

20.6 Discussion Research data were collected by distributing questionnaires to respondents. Questionnaires were distributed by meeting respondents directly, or they were indirectly filled out by respondents who were visitors at tourist sites. Collecting data directly by meeting respondents is expected to be more effective as one can directly explain each question in the questionnaire. The data obtained from the data processing questionnaire is as follows: a b c d

The number of questionnaires distributed for this study was 177. The number of questionnaires returned was 149 ( 84%). The number of questionnaires that can be used was 149 (84%). The number of questionnaires that could not be used was 28 (16%). 20.6.1 Characteristics of respondent profiles

The subjects in this study were visitors to tourist attractions and the samples drawn were 149 respondents. The respondents in this study were: a b

male respondents (20) and female respondents (129)

Most respondents to halal tourism were women. Based on the above data, the 149 respondents took part in the halal tourism study were grouped into 3 categories: (i) age 25 years. One respondent was 25 years and one respondent was 0.95), TLI (>0.95), and RMSEA (≤0.08) were calculated. All values of the three measurement constructs were showing an acceptable fit. Table 21.3 shows the fit indices in the CFA of measurement constructs as follows: The present study investigates the correlation coefficients of the constructs (See Table 21.4). Correlation values were between +1 and −1. If value is closer to +1, then there will be a strong positive correlation. If correlation value is closer to −1, then there will be a strong negative correlation (Wang and Wang, 2012). This study examined that the correlation among all constructs was positive and significant. This study found a strong and positive correlation between service quality and loyalty behavior. There was also a strong and positive correlation between service quality and customer satisfaction. 21.4.1 Structural equation modeling Secondly, the structural equation modeling (SEM) technique was used to test the regression coefficients known as path coefficients. Mplus 7 was used to test the regression analysis by following the bootstrap technique. The path coefficient standard values falling between +1 and −1 (Coltman, 2008; Hair et al., 2013; Roni et al., 2015) suggest that path model coefficient being closer to +1 indicates a high positive effect and the reverse indicates a high 322

I S L A M I C B A N K I N G A N D C U S T O M E R S E RV I C E

negative effect. The rejection and acceptance of the hypothesis depend upon two parameters known as t-value and p-value. The present study used the standardized findings of the measurement tests. The measurement model addressed the basis for the SEM and latent constructs modeling was used to test the hypothesized relationship. Model 1 shows the direct pathways of having used constructs in the present study. The results showed that the service quality has a strong direct positive and significant effect on customer satisfaction at (β = 0.901***, p = 0.000) and has a direct positive and significant effect on loyalty behavior at (β = 0.452**, p = 0.001). Customer satisfaction has also a direct positive and significant effect on loyalty behavior at (β = 0.548***, p < 0.000). Therefore, all three direct hypothesized relationships were accepted and supported. The findings of the present study are consistent with the literature study (Alnaser et al., 2018). The direct effects model meets the requirements of the acceptable fit to the data with the given results (Figure 21.2). The present study found an indirect relationship between service quality and loyalty behavior through the mediating role of customer satisfaction. Model 2 shows the indirect pathway to test the hypothesized relationship. It was examined that service quality has an indirect positive and significant effect on loyalty behavior at (β = 0.494***, p = 0.000). However, hypothesis 4 was accepted and supported as service quality was found to be a significant direct and indirect predictor of loyalty behavior in the form of repurchase intention. The direct effect of service quality on loyalty behavior was significant at (β = 0.452**, p = 0.001) and indirect effect was also significant at (β = 0.494***, p = 0.000). Additionally, it was found that there was partial mediation of customer satisfaction between service quality and loyalty behavior. The indirect effect model also fulfills the requirements of the acceptable fit to the data (Figure 21.3). Table 21.5 below shows that the coefficient of determination (R²) is the most important measure to test structural model fitness. R² evaluates the

Customer Satisfaction + Service Quality

H1

.901***

H2

.452**

H3 .548***

Loyalty Behavior

Figure 21.2 Direct Effect of Service Quality (Model 1). Note: χ2 = 847.269; df = 266; CFI = 0.962; TLI = 951; RMSEA = 0.074; AIC = 19515.686; BIC = 19851.597; at significant level; p < 0.05*, p < 0.01**, p < 0.001***.

323

SHAHBAZ AHMED ET AL.

+ Service Quality

.494***

Customer Satisfaction

H4

Loyalty Behavior

Figure 21.3 Indirect Effect of Service Quality (Model 2). Note: χ2 = 847.269; df = 266; CFI = 0.962; TLI = 0.951; RMSEA = 0.074; AIC = 19515.686; BIC = 19851.597; p < 0.05*, p < 0.01**, p < 0.001***.

Table 21.5 Testing the Effect Size Using R Square Variables

Estimate

S.E

Est./S.E

P-Value

Customer satisfaction Loyalty behavior

0.812 0.951

0.037 0.042

21.714 22.508

0.000 0.000

Note: p < 0.05***.

effect of all latent constructs of an independent variable on the dependent variable (Wong, 2013). The present research had good predictive accuracy/ adequacy in terms of R² values because R² is a measure of testing model predictive adequacy (Hair et al., 2013). R² values should be placed between 0 and 1 with a high level of value, and a higher level of predictive accuracy, and vice versa (Hair et  al., 2013). Researchers argue that R² values vary from 0.75, 0.50 to 0.25, which respectively described the strong, moderate, and weak effect (Hair et al., 2014; Hair et al., 2012, 2013; et al., 2014). The effect size of service quality on customer satisfaction is (R2 = 0.812, p = 0.000) greater than 0.75, which is considered to be the strong effect of an independent variable (service quality) on the dependent variable (customer satisfaction). In addition, the effective strength of service quality on loyalty behavior is (R2 = 0.951, p = 0.000), which is also greater than the said value. So, it could say that there was a strong effect of service quality on both customer satisfaction and loyalty behavior. The primary objective of the present study was to analyze the PAKSERV model in the Islamic banks of Pakistan. This study revealed that all proposed hypothesized relationships were accepted and supported. The service quality had a direct positive and significant effect on customer satisfaction and loyalty behavior. The direct hypothesized relationship results are consistent with the results of Alnaser et al. (2018) and Raajpoot (2004). It was proved that each dimension of PAKSERV has a significant contribution toward Islamic banking customers in Pakistan. In addition, many researchers also proved the direct relationship between service quality and customer satisfaction (Ali & Raza, 2015; Amin & Isa, 2008; Dölarslan, 2014; Taylor and Baker, 1994). The direct effect of service quality on loyalty behavior was found by Han and Ryu (2009), who explored that loyalty behavior can be predicted by overall service quality. 324

I S L A M I C B A N K I N G A N D C U S T O M E R S E RV I C E

Furthermore, the indirect effect of service quality on loyalty behavior was also positive and significant by the mediating role of customer satisfaction. The indirect relationship findings are consistent with the literature studies (Bou-Llusar et al., 2001; Izogo & Ogba, 2015; Kim & Lee, 2010; Kim, 2011; Lenka et  al., 2009). A study conducted in the Netherlands shows that customer satisfaction mediates the positive and significant relationship between service quality and customer loyalty (Bloemer et  al., 1998), similarly in Japan as well (Bei and Chiao, 2001). However, this study found the partial mediation between service quality and loyalty behavior and this partial mediation was advocated in the literature study (Caruana, 2002). The proposed hypothesis ‘customer satisfaction has a positive and significant effect on loyalty behavior’ was accepted and supported. It was found that Islamic banking customers have been demonstrating loyalty behavior and repurchase intention when they were satisfied with the services and products of their banks. The findings of this relationship are consistent with the findings of past studies (Brady et  al., 2005; Cronin et al., 2000; Dölarslan, 2014; Oliver, 1999). In addition, the study argued that the customers who are highly satisfied tend to repurchase the product or service (Zeithaml et al., 1996). With the subject of a previous study by Raajpoot (2004), this study also confirms that the dimensions of the PAKSERV model are the most important determinants to test customer satisfaction and loyalty behavior in the Islamic banks of Pakistan. Additionally, the findings of the PAKSERV model are also consistent with Saunders (2008).

21.5 Conclusion Past studies have focused heavily on the importance of customer satisfaction and loyalty in the service sector. However, the evidence on the impact of service quality on customer loyalty is limited with regard to emerging markets. This study found that Islamic banking customers are satisfied with the service quality offered by Islamic banks and they intend to repurchase the products or services of Islamic banks. The study reveals that good service quality attracts more and more customers and their loyalty behavior; in turn, they feel satisfied with Islamic banking products and services and have positive behavior to repurchase those services and products. Findings of this study indicate that customers pay significant attention to service quality and it is very important for banks to retain the customers by maintaining consistent high-level quality standards. This study contributes to the literature by confirming the applicability of the PAKSERV model in explaining customer loyalty in the Islamic banking industry in Pakistan. The results add value to the PAKSERV scale by proving its validity and appropriateness in measuring the service quality of Islamic banks in emerging markets. 325

SHAHBAZ AHMED ET AL.

Islamic banks could use these findings to improve their relationship with customers. This study’s finding recommends Islamic banks in Pakistan to strongly focus on all PAKSERV dimensions. These can be performed by developing excellent infrastructure, esthetically designed communication materials, and customer guidance during new product launches to reduce the extent of perceived risk. In addition, Islamic banks should focus on training employees to develop their understanding of the changing needs of customers. Despite the meaningful contribution, this study is limited due to the purposive sampling method applied to collect the data. In addition, the findings are limited to the Pakistani Islamic banking context. Future studies on the PASKSERV model covering all the banking services and products rather than only Islamic banking in developing countries could provide a comparative overview of the importance of service quality for the banking sector in emerging markets.

References Adjei, M. T., & Clark, M. N. (2010). Relationship marketing in A B2C context: the moderating role of personality traits. Journal of Retailing and Consumer Services, 17(1), 73–79. DOI: 10.1016/j.jretconser.2009.10.001. Al-Hawari, M. (2006). The effect of automated service quality on bank financial performance and the mediating role of customer retention. Journal of Financial Services Marketing, 10(3), 228–243. Ali, M., & Raza, S. A. (2015). Service quality perception and customer satisfaction in Islamic banks of Pakistan: the modified SERVQUAL model. Total Quality Management & Business Excellence, 28(5–6), 559–577. DOI: 10.1080/14783363.2015.1100517. Almossawi, M. (2001). Bank selection criteria employed by college students in Bahrain: an empirical analysis. International Journal of Bank Marketing, 19(3), 115–125. Alnaser, F. M. I., Abd Ghani, M., & Rahi, S. (2018). Service quality in Islamic banks: the role of PAKSERV model, customer satisfaction and customer loyalty. Accounting, 63–72. DOI: 10.5267/j.ac.2017.8.001. Amin, M., & Isa, Z. (2008). An examination of the relationship between service quality perception and customer satisfaction. International Journal of Islamic and Middle Eastern Finance and Management, 1(3), 191–209. DOI: 10.1108/17538390810901131. Anderson, E. W., Fornell, C., & Lehmann, D. R. (1994). Customer satisfaction, market share and profitability. Journal of Marketing, 58(3), 53–66. Anderson, E. W., & Sullivan, M. W. (1993). The antecedents and consequences of customer satisfaction for firms. Market Science, 12(2), 125–143. DOI: 10.1287/ mksc.12.2.125. Angur, M. G., Nataraajan, R., & Jahera Jr, J. S. (1999). Service quality in the banking industry: an assessment in a developing economy. International Journal of Bank Marketing, 17(3), 116–125. Arasli, H., Katircioglu, S. T., & Mehtap-Smadi, S. (2005). A comparison of service quality in the banking industry. International Journal of Bank Marketing, 23(70), 508–526.

326

I S L A M I C B A N K I N G A N D C U S T O M E R S E RV I C E

Ashfaq, M. (2017). Islamic Banking and Finance in Europe: The Case Study of Germany and the United Kingdom: A Theoretical and an Empirical Analysis. Frankfurt: Peter Lang. Ashforth, B. E., & Humphrey, R. H. (1993). Emotional labour in service roles: the influence of identity. Academy of Management Review, 18(1), 88–115. Asubonteng, P., McCleary, K. J., & Swan, J. E. (1996). SERVQUAL revisited: a critical review of service quality. Journal of Service Marketing, 10(6), 62–81. DOI: 10.1108/08876049610148602. Awan, H. M., Bukhari, K. S., & Iqbal, A. (2011). Service quality and customer satisfaction in the banking sector: a comparative study of conventional and Islamic banks in Pakistan. Journal of Islamic Marketing, 2(3), 203–224. Bei, L.-T., & Chiao, Y.-C. (2001). An integrated model for the effects of perceived product, perceived service quality, and perceived price fairness on consumer satisfaction and loyalty. Journal of Consumer Satisfaction, Dissatisfaction and Complaining Behavior, 14(1), 125–140. Bitner, M. J. (1990). Evaluating service encounters: the effects of physical surroundings and employee responses. Journal of Marketing, 54(April), 69–82. Bloemer, J., Ruyter, K., & Peeters, P. (1998). Investigating drivers of bank loyalty: the complex relationship between image, service quality and satisfaction. International Journal of Bank Marketing, 16(7), 276–286. Brady, M. K., Knight, G. A., Cronin, J. J., Tomas, G., Hult, M., & Keillor, B. D. (2005). Removing the contextual lens: a multinational, multi-setting comparison of service evaluation models. Journal of Retailing, 81(3), 215–230. DOI: 10.1016/j. jretai.2005.07.005. Bou-Llusar, J. C., Camison-Zornoza, C., & Escrig-Tena, A. B. (2001). Measuring the relationship between firm perceived quality and customer satisfaction and its influence on purchase intentions. Total Quality Management, 12(6), 719–734. Byrne, B. M. (2012). Structural Equation Modelling with Mplus: Basic Concepts, Applications and Programming. New York: Routledge Taylor & Francis group. Caruana, A. (2002). Service loyalty: the effects of service quality and the mediating role of customer satisfaction. European Journal of Marketing, 36(7/8), 811–828. Caruana, A., Money, A. H., & Berthon, P. R. (2000). Service quality and satisfaction-the moderating role of value. European Journal of Marketing, 34(11/12), 1338–1353. Chang, Y. W., & Polonsky, M. J. (2012). The influence of multiple types of service convenience on behavioral intentions: the mediating role of consumer satisfaction in a Taiwanese leisure setting. International Journal of Hospitality Management, 31(1), 107–118. Cheruiyot, T. K., & Maru, L. C. (2013). Service quality and relative performance of public universities in East Africa. The TQM Journal, 25(5), 533–546. Coltman, T., Devinney, T. M., Midgley, D. F., & Venaik, S. (2008). Formative versus reflective measurement models: two applications of formative measurement. Journal of Business Research, 12, 1250–1262. Comrey, A. L., & Lee, H. B. (1992). A First Course in Factor Analysis, 2nd ed. Hillsdale, NJ: Erlbaum. Cronin, Jr., J. J., & Taylor, S. A. (1994). SERVPERF versus SERVQUAL: reconciling performance-based and perceptions-minus-expectations measurement of service quality. Journal of Marketing, 58(1), 125–131.

327

SHAHBAZ AHMED ET AL.

de Wulf, K. (2003). In van Looy, B. et  al. (Eds.), Services Management. Harlow: Prentice-Hall. Dölarslan, E. S. (2014). Assessing the effects of satisfaction and value on customer loyalty behaviours in service environments. Management Research Review, 37, 706–727. DOI: 10.1108/MRR-06-2013-0152. Hair, J. F., Black, W. C., Babin, B. J., & Anderson, R. E. (2010). Multivariate Data Analysis: A Global Perspective. Upper Saddle River, NJ: Pearson Education Press. Hair, J. F., Hult, G. T. M., Ringle, C. M., & Sarstedt, M. (2014).A Primer on Partial Least Squares Structure Equation Modeling (PLS-SEM). Thousand Oaks, CA: SAGE Publications, Inc. Hair, J. F., Ringle, C. M., & Sarstedt, M. (2013). Partial least squares structural equation modeling: rigorous applications, better results and higher acceptance. Long Range Planning, 46, 1–12. Hair, J. F., Sarstedt, M., Pieper, T. M., & Ringle, C. M. (2012). The use of partial least squares structural equation modeling in strategic management research: a review of past practices and recommendations for future applications. Long Range Planning, 45, 320–340. Han, H., & Ryu, K. (2009). The roles of the physical environment, price perception, and customer satisfaction in determining customer loyalty in the restaurant industry. Journal of Hospitality and Tourism Research, 33(4), 487–510. Hu, L., & Bentler, P. M. (1999). Cut off criteria for fit indexes in covariance structure analysis: conventional criteria versus new alternatives. Structural Equation Modelling, 6(1), 1–55. Izogo, E. E., & Ogba, I.-I. (2015). Service quality, customer satisfaction and loyalty in the automobile repair services sector. International Journal of Quality and Reliability Management, 32(3), 250–269. Jabnoun, N., & Hassan Al-Tamimi, H. A. (2003). Measuring perceived service quality at UAE commercial banks. International Journal of Quality & Reliability Management, 20(4), 458–472. Jamal, A., & Naser, K. (2002). Customer satisfaction and retail banking: an assessment of some of the key antecedents of customer satisfaction in retail banking. International Journal of Bank Marketing, 20(4), 146–160. Jiang, P., & Rosenbloom, B. (2005). Customer intention to return online: price perception, attribute-level performance, and satisfaction unfolding over time. European Journal of Marketing, 39(1/2), 150–174. DOI: 10.1108/03090560510572061. Kim, H. J. (2011). Service orientation, service quality, customer satisfaction, and customer loyalty: testing a structural model. Journal of Hospitality Marketing and Management, 20(6), 619–637. Kim, Y.-E., & Lee, J.-W. (2010). Relationship between corporate image and customer loyalty in mobile communications service markets. Africa Journal of Business Management, 4(18), 4035–4041. Lam, S. S., & Woo, K. S. (1997). Measuring service quality: a test-retest reliability investigation off SERVQUAL. International Journal of Market Research, 39(2), 381–396. Laroche, M., Ueltschy, L. C., Abe, S., Cleveland, M., & Yannopoulos, P. P. (2004). Service quality perceptions and customer satisfaction: evaluating the role of culture. Journal of International Marketing, 12(3), 58–85.

328

I S L A M I C B A N K I N G A N D C U S T O M E R S E RV I C E

Lenka, U., Suar, D., & Mohapatra, P. K. J. (2009). Service quality, customer satisfaction, and customer loyalty in Indian commercial banks. Journal of Entrepreneurship, 18(1), 47–64. Levesque, T., & McDougall, G. H. G. (1996). Determinants of customer satisfaction in retail banking. International Journal of Bank Marketing, 14(7), 12–20. Malhotra, N. K., Ulgado, F. M., Agarwal, J., Shainesh, G., & Wu, L. (2005). Dimensions of service quality in developed and developing economies: multi-country cross-cultural comparisons. International Marketing Review, 22(3), 256–278. Maxham, J. G. (2001). Service recovery’s influence on consumer satisfaction, positive word-of-mouth, and purchase intentions. Journal of Business Research, 54(1), 11–24. DOI: 10.1016/S0148-2963(00)00114-4. Oliver, R. (1980). A cognitive model of the antecedent and consequences of satisfaction decisions. Journal of Marketing, 17(10), 460–469. Oliver, R. L. (1999). Whence consumer loyalty. Journal of Marketing, 63(4), 33–44. Parasuraman, A. (1998). Customer service in business-to-business markets: an agenda for research. The Journal of Business & Industrial Marketing, 13(4), 309. Parasuraman, A., Berry, L. L., & Zeithaml, V. A. (1991). Refinement and reassessment of the SERVQUAL scale. Journal of Retailing, 67(4), 420. Parasuraman, A., Zeithaml, V. A., & Berry, L. L. (1985). A conceptual model of service quality and its implications for future research. Journal of Marketing, 49(4), pp. 41–50. Parasuraman, A., Zeithaml, V. A., & Berry, L. L. (1988). Servqual. Journal of Retailing, 64(1), 12–40. Parasuraman, A., Zeithaml, V. A., & Berry, L. L. (1994). Alternative scales for measuring service quality: a comparative assessment based on psychometric and diagnostic criteria. Journal of Retailing, 70(3), 201–230. Pihlström, M., & Brush, G. (2008). Comparing the perceived value of information and entertainment mobile services. Psychological Marketing, 25(8), 732–755. DOI: 10.1002/mar.20236. Raajpoot, N. (2004). Reconceptualizing service encounter quality in a non-western context. Journal of Service Research, 7(2), 181–201. Rahi, S., Ghani, M. A., & Alnaser, F. M.-I. (2017). The influence of e-customer services and perceived value on brand quality of banks and internet banking adoption: a structural equation model (SEM). Journal of Internet Banking and Commerce, 22(1), 1–18. Raza, S. A., Jawaid, S. T., & Hassan, A. (2015). Internet banking and customer satisfaction in Pakistan. Qualitative Research in Financial Markets, 7(1), 24–36. Roni, S. M., Djajadikerta, H., & Ahmad, M. A. N. (2015). PLS-SEM approach to second-order factor of deviant behaviour: constructing perceived behavioural control. Procedia Economics and Finance, 28, 249–253. Saunders, S. G. (2008). Measuring and applying the PAKSERV service quality construct: Evidence from a South African cultural context. Managing Service Quality: An International Journal, 18(5), 442–456. SBP. (2019). Islamic Banking Bulletin. Online. Available at http://www.sbp.org.pk/ ibd/bulletin/2019/Mar.pdf (accessed on 29 December 2019). Tam, J. L. M. (2004). Customer satisfaction, service quality and perceived value: an integrative model. Journal of Marketing Management, 20(7/8), 897–917. DOI: 10.1362/ 0267257041838719.

329

SHAHBAZ AHMED ET AL.

Taylor, S. A., & Baker, T. L. (1994). An assessment of the relationship between service quality and customer satisfaction in the formation of consumers’ purchase intentions. Journal of Retailing, 70(2), 163–178. Terrence Levesque, G. H. G. M. (1996). Determinants of customer satisfaction in retail banking. International Journal of Bank Marketing, 7(14), 12–20. Uncles, M. D., Dowling, G. R., & Hammond, K. (2003). Customer loyalty and customer loyalty programs. Journal of Consumer Marketing, 20(4), 294–316. Vazquez-Casielles, R., Suarez-Alvarez, L., & Del Rio-Lanza, A. B. (2009). Customer satisfaction and switching barriers: effects on repurchase intentions, positive recommendations, and price tolerance. Journal of Applied Social Psychology, 39(10), 2275–2302. DOI: 10.1111/j.1559-1816.2009.00526.x. Yieh, K., Chiao, Y., & Chiu, Y. (2007). Understanding the antecedents to customer loyalty by applying structural equation modeling. Total Quality Management, 18(3), 267–284. Yoo, D. K., & Park, J. A. H. (2007). Perceived service quality: analyzing relationships among employees, customers, and financial performance. International Journal of Quality & Reliability Management, 24(9), 908–926. Wang, Y., Lo, H. P., & Hui, Y. V. (2003). The antecedents of service quality and product quality and their influences on bank reputation: evidence from the banking industry in China. Managing Service Quality: An International Journal, 13(1), 72–83. Wang, J., & Wang, X. (2012). Structural Equation Modelling: Applications Using Mplus. Chichester: Wiley & Sons Inc. Wong, K. K.-K. (2013). Partial Least Squares Structural Equation Modeling (PLSSEM) Techniques Using SmartPLS, 24, 1–32. http://marketingbulletin.massey. ac.nz. Zeithaml, V. A., Berry, L. L., & Parasuraman, D. B. A. (1996). The behavioural consequences of service quality. Journal of Marketing, 60(2), 31–46. Zhang, J., & Bloemer, J. M. M. (2008). The impact of value congruence on consumerservice brand relationships. Journal of Service Research, 11(2), 161–178. DOI: 10.1177/1094670508322561. Zhu, F. X., Wymer, W., & Chen, I. (2002). IT-based services and service quality in consumer banking. International Journal of Service Industry Management, 13(1), 69–90.

330

22 GREEN SUKUK FOR FINANCING RENEWABLE PROJECTS IN ISLAMIC SOCIAL FINANCE Problems and solutions Maryam Saeed 22.1 Introduction This study aims to find solutions to the energy crises and global warming through green sukuk, which is connected with many renewable projects like harnessing solar and wind power and using electric vehicles. These projects will resolve the energy crises and the emission level of CO2 in the climate of Pakistan, which will also deliver a social dividend and an economic return. Social investors can affect environmental return by investing in green sukuk. Money collected through issuing green sukuk by mudarbah companies can be invested in projects involving solar panels and wind energy systems and in free carbon-based vehicles that do not pollute climate. Practical use of shari’ah-compliant sukuk instruments to develop methods of technological innovation in the energy production sector can offer policy makers a quick look at different financing instruments available for the renewables sector in the framework of the lessening of GHG emissions (YoungMan & Muhammad, 2018). The growth of a green sukuk market can sponsor environment-friendly projects and develop livelihoods and help in Islamic finance for achieving its moral objectives (Dalal et  al., 2018). The sukuk market has been flourishing all over the world and is an alternative to conventional bonds for investing in interest-free investments. With regard to the Auditing and Accounting Organization of Islamic Financial Institutions (AAOIFI), sukuk was officially defined in May 2003 as a certificate of equal value that represents undivided shares in the ownership of tangible assets, usufruct, and services or ownership of the asset of a particular project or special investment activity. The main difference between sukuk and bond is that interest is paid at regular intervals to investors on bonds

DOI: 10.4324/9781003050209-22331

M aryam S aeed

whereas profit and loss are shared by the issuer with the involved parties on sukuk. Sukuk is subdivided into asset-based and asset-backed sukuk. Asset-backed sukuk comprises mudarbah and musharkah and the remaining Islamic financing modes like murabahah, istisna, salam, and ijarah fall into the asset-based category. Sukuk is further extended toward green sukuk. Green sukuk is a shari’ah-compliant investment that is invested in renewable energy and other environmental assets. The purpose of the investment is to preserve the environment, natural resources, promoting renewable technologies, and reducing greenhouse gas emissions. In 2012, Climate Bonds Initiative (CBI) in cooperation with Clean Energy Business Council of the Middle East and North Africa (MENA) and Dubai-based Gulf Bond & Association, ascertained a green sukuk working group to encourage the idea of green sukuk with low carbon criterion (Ali & Abdullah, 2017). Global sukuk issuances in 2017 show a growth rate of 22.8%, with the total volume of annual issuances reaching US$ 91.9 billion as compared with US$ 74.8 billion in 2016 (IFSB, 2018). Green sukuk has the prospective to play a vital role in assisting the enactment of the sustainable development goals (SDGs). Therefore, literature studies help to investigate the interlinked concepts of green sukuk, renewable projects, and Islamic social finance. For this purpose, mudarbah-based companies were interviewed about the implementation and the possibility of a green sukuk-based investment model in Pakistan. The objective of this chapter is to discuss the conceptual nature of green sukuk in renewable projects. There are two main objectives: To explore the role of green sukuk in resolving energy crises To explore the role of green sukuk in the reduction of global warming Though conceptual, it may offer relevance to practitioners and academicians of Islamic finance especially toward understanding the concepts and mechanisms involved in green sukuk models. Furthermore, there are limited academic papers on green sukuk in collaboration with renewable projects. Therefore, this chapter fills an enormous gap in academia. The chapter follows the development of sukuk from its historical background to its modern advancement. It begins with a brief introduction on the history of sukuk. The following sections present a literature review representing the association of green sukuk with renewable projects (harnessing solar and wind energy and using electric vehicles) and Islamic social finance and discuss the conceptual framework of the whole idea. The final section contains interview-based findings, recommendation, limitation, future direction, and some concluding remarks.

332

G R E E N S U K U K F O R R E N E WA B L E P RO J E C T S

22.2 Background of sukuk and its recent development “Sukuk” is the Arabic name for a monetary certificate and it is the equivalent of a bond (Tan Wan, 2009). According to the AAOIFI standard norm number 17, sukuk is defined in the form of certificates that represent undivided shares of sukukholders in the possession of concrete assets, usufructs, and services and in the assets of particular projects (Patel, 2015). The first sukuk transaction took place in Damascus in its Great Mosque in the 7th century AD. Muslim traders are known to have used the check or ṣakk system since the time of Harun al-Rashid (9th century) of the Abbasid Caliphate (Subhi, 1969). Sukuk is the alternative to conventional bonds that are impermissible by shari’ah due to the interest gained and in many non-shari’ah-compliant businesses that deal in gambling, alcohol, pork, etc. Sukuk securities are designed according to shari’ah wherein profit is paid through investment as a tangible asset. For example, people can buy sukuk securities by which money is invested in buying property by a special purpose vehicle (SPV) who purchases assets on behalf of sukukholders who are considered as real owners of real assets. Afterward, asset/property is given on rent, which is distributed among the owners. Rent is allowed under Islamic law in the place of interest. There are many structures of sukuk, for example, mudarbah sukuk, musharkah sukuk, ijarah sukuk, murabahah sukuk, salam sukuk, istisna sukuk, and hybrid sukuk. Mudarbah sukuk consists of three parties: sukukholders, SPVs, and third parties. In the first type of relationship, sukukholders and SPVs are involved. SPVs have the right to issue sukuk securities that are bought by sukukholders who also called rab al-mal. The mudarib or any other SPV invests money in those businesses that demand money. In the second relationship, SPVs and third parties are involved where the SPV becomes the rab al-mal and the third party becomes the mudarib who invests money in his or her businesses. In case of profit, the issuer SPV receives the mudarbah profits and holds them as the trustee on behalf of the investors. The issuer SPV (as trustee) pays each periodic return to investors using the mudarbah profit, which is received under the mudarbah agreement. In case of loss, the rab al-mal bears all losses and the mudarib bears the loss of the professional fees received against efforts and skills for managing the enterprise. Ijarah is a lease contract in Islamic finance, and it is known as ijarah sukuk based on the leasing scheme. The SPV issues ijarah-based sukuk securities that are bought by sukukholders. The SPV buys a property or machinery on behalf of the investors after collecting the money, which is leased to another party for a fixed time period. Rent from this property is shared among sukukholders. In the end, the said property is sold and the amount is distributed among sukukholders at the end of the maturity period.

333

M aryam S aeed

Murabahah is a monetary contract whereby one party buys an asset and sells it on an overdue basis for a decided marked-up rate that includes cost and profit margins. SPV collects money through sukuk issuance bought by sukukholders, then buys commodities on a given price, which are later sold on higher rates. The difference between cost price and selling price is distributed among sukukholders. Musharakah is a sukuk structure that consists of a profit-and-loss-sharing system where two or more parties share profits and losses generating from a joint enterprise. All partners invest in musharakah-based businesses. Profits are disseminated in an equally decided quantity by all the partners. All assets in the business enterprise are equally owned in quantity to the capital of each partner. The musharakah (partnership) is between the two parties namely: corporate and SPV. They sign a profit-sharing arrangement for the preset period of time on a decided profit ratio. Profits are dispersed to sukukholders. At maturity, the corporate purchases all shares of the SPV asset, and this amount is dispersed among sukukholders at the end of maturity date. Salam sukuk is sold by an SPV. Collected funds from investors are paid as advance to the company in return for an undertaking to send the goods at a future date. The SPV can also choose a representative to sell the same amount of goods at a higher price after the delivery of goods from a company. Profits from these activities are passed by the SPV to sukukholders. Istisna sukuk is similar to salam sukuk. The difference is in the items, as manufacturing items are included in the istisna contract. Istisna sukuk is helpful for financing huge infrastructure projects. In a hybrid structure, a combination of the above sukuk is designed (Seikh & Shan, 2010).

22.3 Literature review 22.3.1 Green sukuk and renewable projects (solar and wind) Green sukuk is a shari’ah-compliant product that protects the environment. It can be invested in environment-friendly projects including solar parks, bio-gas plants, and wind farms. This is the ideal investment mechanism for shari’ah followers of South East Asia and the Gulf Cooperation Council region. It also encourages corporate social responsibility (Alam et al., 2016). Ethical investment is one of the tenets of Islamic principles. Accordingly, green bonds and green sukuk as environment-friendly products fall within the territory of shari’ah objectives. The framework of socially responsible investment (SRI)  sukuk is a further extension of the present sukuk. All guidelines of the present model (sukuk) can also be applied to this new concept/model (SRI Sukuk) (Ullah, 2015). Investors in sukuk can be Islamic insurance companies, Islamic pensions funds, asset management companies, and other investors who want 334

G R E E N S U K U K F O R R E N E WA B L E P RO J E C T S

a variation in investment in shari’ah-compliant instruments. Islamic bonds comprise two categories: debt-based and equity-based bonds. Debt-based bonds can be referred to as sales-based trade wherein payment is deferred. Equity-based sukuk i.e. musharakah and mudarbah denote ownership and shares of all issuers on particular projects (Ullah, 2015). Renewability is a key element of EU energy policy in 2020 strategy where the plan has been to reduce greenhouse gases to 20% below 1990 levels, and a reduction of 80–95% below 1990 levels by 2050. Sukuk as an Islamic financial instrument can be used in renewable projects that have the capability to fulfill EU energy needs through investments in developing technologies, i.e. photovoltaic systems. Each year, these PV installations save million tons of CO2. In the EU, a dedication from policy makers increased incentives that resulted in the constant growth of PV installations. Factors other than incentives also have the most important role that can differ from one country to another (Morea & Poggi, 2016). Pakistan has been relying on the following energy sources: natural gas (47%), oil (31%), hydroelectricity (11%), coal (9%), liquefied petroleum gas (1%), and nuclear energy (1%). Renewable sources of energy have been ignored. The violating rates of oil in the international market disturb the growth of the whole economy of Pakistan. Renewable projects are not being utilized due to the following reasons: lack of agreement between federal and provincial governments about ownership and control of the project, lack of technical and administrative capacity. Pakistan has a huge potential of using wind energy i.e. 350,000 MW in the vicinity of Sindh and Balochistan. Pakistan is in a sunny belt, but utilization of solar power is less due to the requirement of a higher investment for the infrastructure of the solar plant and lack of silicon semiconductor industry (Qureshi, 2009). The main issue is levels of carbon emissions in each country and their commitment toward its reduction in the future in the shape of intended nationally determined contributions (INDCs). A small investment loan program regarding climate change can be offered in each province for projects using solar panels in agricultural and industrial fields. Pakistan, through its own climate change investment bank (CCBI), can design a local climate change action plan and strategy for each province, which can be downscaled to the district level through a structured fiscal system for the implementation of the action plan. The CCBI can offer a mitigation fund for energy and emission projects. In this way, the SBP can generate funds locally and internationally for renewable projects. The strengthening of institutions in Pakistan would encourage investors to invest in climate change projects. Climate change bond/certificate/Pakistan green climate bonds can be backed by the federal government with full partnership of the SBP but issued by the CCBI for five to ten or longer years (Mallick, 2016). Fossil fuels, i.e. oil, gas, and coal, are made from global warming, which leads to very serious environmental problems (Stern, 2006). 335

M aryam S aeed

22.3.2 Green sukuk and renewable projects (electric vehicle) Green bonds or green sukuk comprises fixed-income securities issued to obtain capital for further financing of activities toward environmental development (Laskowska, 2017). Prudential guidelines on infrastructure investment play a vital role in facilitating an environment for organizing long-term finance from institutional investors (Jobst, 2018). In major developing countries like China and India whose population has been growing and therefore standard of living ought to be improving proportionately, energy, i.e. crude oil, for industries, has an essential market. However, pollution arising from fossil fuel emission causing global warming has now turned the attention toward the use of renewable sources of energy (Ramady, 2018). People in Pakistan have more inclination toward buying alternate vehicles than fuel vehicles in the highly regulated automobile industry regardless of the operational costs and infrastructural obstacles. This stance shows a great potential in terms of business return and environmental protection if capital is invested in the infrastructure for promoting the use of electric vehicles. Furthermore, participants prefer more of auto brands that are fuelefficient in terms of consumption and range (Saleem et al., 2018). According to the studies conducted in China, people’s personal norms and cost of electric vehicles motivate their purchases (Vermeir & Verbeke, 2006). As per the report from Outlook in 2016, government through tax credit or incentive promotes electric vehicles, i.e. China gives a rebate on registration and exemption on sales tax. USA gives tax credit. Norway gives VAT and sales tax exemption and waivers on parking and toll fees. Government is also encouraging manufacturers of electric vehicles by tightening the emission norms, i.e. India has not much of a market share for electric vehicles but still imposes stringent emission norms. India has imposed Bharat stage IV norms nationwide on automobiles and had decided to impose Bharat V directly until 2020. Indian government promotes taxi services and electric buses in some states and also works on lowering taxes and interest rates on electric vehicles and stopping petrol or diesel cars (Kumar et al., 2017). 22.3.3 Green sukuk and Islamic social finance Islamic capital markets can help social welfare originators to increase funds to finance their projects through different shari’ah-compliant financing instruments, such as sukuk, mutual funds, and real estate unit trusts (Ahmed, 2019). Islamic social finance refers to the endowment of financial services to susceptible members of the Islamic society to attain socio-economic well-being. It consists of three main sectors namely zakat, waqf, and Islamic microfinance. Waqf fund can be capitalized through sukuk for social services. Beneficiaries can donate contributions via zakat or sadqa or waqf, 336

G R E E N S U K U K F O R R E N E WA B L E P RO J E C T S

which would be managed by a SPV who will further invest in filling the philanthropic gap (Ibrahim & Ajayi, 2019). Indonesia is a global leader on zakat for the SDGs. UNDP Indonesia team worked with BAZNAS, the national zakat collection agency to apply zakat funds for local SDG plans, opening renewable energy projects in underserved communities. Islamic social finance has been helping to link investors with SDG-aligned projects, including expanding Green Sukuk opportunities (Ulrika, 2018). In modern times, Islamic social finance may also cover modern forms of Islamic financial services, such as Islamic microfinance, sukuk, and takaful (Apnizan, 2019).

22.4 Conceptual framework The objective of this is to explore the role of green sukuk in renewable projects to reduce the global emission contributing to climate change and address the energy shortage due to more reliance on oil and gasoline in Pakistan (Figure 22.1). The above diagram denotes the model of a green sukuk, which can be issued by mudarbah and leasing-based companies in Pakistan such as First Punjab Modaraba, First Habib Modarba, and SME Leasing. Investment from sukukholders can be invested in companies manufacturing solar panels and wind plants, which will be helpful for companies to get more investment for more production of renewable technology. Government bodies such as Punjab Energy Department must relax import duty and tariff and taxes on renewable technology and reduce sales tax rates. The Alternative Energy Development Board (AEDB) has also availed a revised SBP financing scheme for renewable projects to invest in green sukuk issued by the mudarbah and leasing companies of renowned banks i.e. Habib Bank, Bank of Punjab, and SME Leasing Company. The Federal Board of Revenue (FBR) can make and implement policies that benefit renewable projects through a relaxation in taxes. According to Ansari in 2011, FBR announced a restrictive exemption from sales tax and federal excise duty on the import and local supply of renewable energy equipment such as solar PV panels and other instruments. Importers and suppliers of solar and wind energy equipment and alternative energy devices require a certificate from the AEDB for exemption from sales tax and federal excise duty. NBFI and mudarbah can also evaluate the performance of the green sukuk of issuers. Credit-rating companies, e.g., The Pakistan Credit Rating Agency Limited, can give a rating based on one factor: the company’s stability fund. The above-mentioned companies relating to solar and wind projects can invest money from mudarbah leasing companies in manufacturing and 337

M a rya m S a e e d

Government and regulatory bodies Regulate

Regulate Alternave Energy Development Board (AEDB) Punjab energy Department (Solar) SECP/SBP/NBFI & Modaraba Associaon of Pakistan Mudarabah Companies

Renewable Projects (Wind, Solar, electric vehicle projects) Sun Life Solar

First Punjab Modaraba

Ikram Solar Industries (Pvt.) Ltd

First Habib Modaraba SME

Hadron Solar

Leasing Limited

Master Group (Wind)

NBP Modaraba MCB Modarba

Give proceeding

Sharif Internaonal (Wind, Solar)

Receive monthly proceeding Receive proceeding at maturity

Sukukholders

Receive proceeding Distribute sukuk proceeding Distribute amount at maturity

Resolve Energy crises and global warming in Pakistan

Figure 22.1  Investment of Green Sukuk in Renewable Projects. Source: Own elaboration.

selling renewable technology. Revenue collected through sales can be given to the mudarbah companies that will further distribute to sukukholders. On maturity, solar and wind energy companies will pay mudarbah companies in full, who, in turn, will distribute it to sukukholders. This model will work on the basis of the sukuk ijarah bai tamleek, murabahah, musharkah, or mudarbah concept. On electric vehicle projects, Pakistan Environmental Protection Agency, which is a Department of the Ministry of Climate Measure, can control and implement pollution-control policies. They can 338

G R E E N S U K U K F O R R E N E WA B L E P RO J E C T S

work with solar and wind projects to implement the emission standards and can work with vehicle manufacturer companies in Lahore to minimize the level of smoke emitting from vehicles that play a greater part in causing air pollution. All relevant government authorities can cooperate in reducing global warming by providing support to renewable projects, i.e. harnessing solar and wind energy and using electric vehicles. They can check the emission level and publish a report on the emission level of renewable projects, which will also boost the confidence of sukukholders about their investments in green projects. According to Jamal in 2017, Nishat Group has made an agreement with Hyundai Motor Company to set up a car assembly plant in Pakistan for launching electric and hybrid cars. Pakistan Automotive Manufacturers Association can give incentives in the form of rebates on registration and exemption from sales tax, tax credit, and VAT, waivers on parking and toll fees, and tightening emission norms to promote the purchase of electric vehicles. In the above renewable projects, mudarbah companies can invest through green sukuk by using different Islamic financing modes like musharkah, mudarbah, and ijarah.

22.5 Research methodology This study intends to explore the role of green sukuk in energy crises, global warming, and Islamic social finance in Pakistan. For this purpose, the qualitative method is used for probing facts and revealing thoughts and opinions of expert specialists. Interpretive approaches depend deeply on naturalistic methods like interviewing and observation and analysis of existing texts. It is exploratory research for finding out the exact nature of the problem. Target population consisted of all managers of mudarbah companies and investment companies in Lahore. Sample size consisted of five managers from mudarbah and investment companies, i.e. SME Leasing Company, NBP Modaraba Management Company, MCB Mudarbah Company, First Habib Modaraba, and First Punjab Modaraba. Purposive sampling technique is chosen for collecting data from relevant experts. Purposeful sampling is a method used in a qualitative study for identifying and selecting knowledgeable individuals with restricted means (Patton, 2002). Data collection method comprises semi-structured interviews designed by focusing on group discussions with relevant experts in this field. Faceto-face interview discussions with people from five mudarbah companies in Lahore were held from February to June 2018 by using references and appointments. 339

M aryam S aeed

In qualitative research, several analysis methods can be used, for example, phenomenology, hermeneutics, grounded theory, ethnography, and phenomenographic and content analyses (Burnard, 1995). Content analysis is applied for analyzing the content from managers who repeated the same mistakes in the implementation of renewable projects (wind, solar, and electrical vehicles) for green sukuk in Pakistan, especially in Lahore. In qualitative content analysis, data are presented in words and themes, which make it possible to make some interpretation of the results. Silverman (2003) offers a sound interpretation that the reliability of qualitative data can be examined by comparing the analysis of the same data by several observers. For this purpose, another observer assisted in giving his viewpoint on the content that was collected after taking interviews of mangers of five mudarbah companies. The second observer also derived the same meaning or result, which is discussed in the Results section. For validity of the responses, respondent validation method was used wherein contents/words of one mudarbah manger was also discussed with another mudarbah manager during interviews. This method confirmed the issues that are discussed in the Results section.

22.6 Results/findings The following findings were derived from interviews. 22.6.1 High risk It is found that green sukuk is not popular yet in Pakistan due to the high risk involved in the implementation of renewable projects (solar and wind plants and electric vehicles). 22.6.2 Lack of investment Renewable projects require a huge amount for investment. Investors avoid renewable projects due to the lack of government financial support to these projects, fearing a loss of investment. Banks are also not willing to give loans to such big projects. 22.6.3 Lack of government support There is a lack of support from the government in terms of incentive or tax rebates or awareness programs for promoting such renewable projects that can encourage relevant industries to overcome load-shedding and globalwarming challenges. Government departments lack the capacity for solar planning and innovative strategies. 340

G R E E N S U K U K F O R R E N E WA B L E P RO J E C T S

22.6.4 Lack of public awareness Electric vehicles are not in much demand in Pakistan due to a lack of public awareness about their features and their positive impact on the environment/climate, which is very essential to understand the rise in global temperature day by day. 22.6.5 Lack of infrastructure Lack of infrastructure in terms of charging and maintenance stations for electrical vehicles is also an issue. To implement such renewable projects, investment via green sukuk in the relevant market is very risky. The solar industry of Pakistan is also in its infancy, which is why banks avoid investing in such renewable projects. 22.6.6 Lack of commitment Industries do not take the pollution resulting from production processes seriously. 22.6.7 Infancy phase of local solar manufacturing Local solar manufacturing is in its infancy. They need a lot of investment and training in the development of the solar industry and human resources. 22.6.8 Technical issues Governments do not have any certification system for technicians. Solar enterprises encounter obstacles from the import to installation of solar panels. They depend on foreign personnel for installation and operation of large energy projects. 22.6.9 Dependence on foreign technology There is no production facility for solar cells, so the solar industry depends on the import of foreign technology. 22.6.10 Net metering There is no system of grid system and metering to encourage the use of solar energy and attract investors. 22.6.11 Lack of a regulatory body A regulatory body is required to issue licenses to vendors to sell solar panels. 341

M aryam S aeed

22.7 Recommendation 1

2

3

4 5 6

7

Due to load-shedding, the demand for electricity is high, which is not being fulfilled by the current infrastructure of WAPDA; shifting toward renewable projects involving wind and solar power will not only address the energy crises, but it is also beneficial for both the industry and consumers. Consumers can use solar energy directly from the sun so electricity cost will be minimized. Industry will also grow as the market share is high for solar panels and their maintenance, which is potentially profitable. It will also reduce the dependence on a petrol source that covers a substantial amount of GDP. For implementing the above renewable projects, government, with AEDB and FBR, can create tax policies, take up project implementation planning, and invest in green sukuk for promoting relevant industries on renewable projects for making solar panels available for every household. For electric vehicles, although brands in Pakistan like Honda and Toyota have already worked on such projects, introducing electric vehicles in Pakistan is difficult due to infrastructural challenges. Electric charge stations are required to be built at various localities and battery cost and maintenance need to be factored in. Public awareness is also an issue as people are unsure whether an electric vehicle will cover long journey/distances or not. Government can offer tax incentives on the import of renewable technology and other benefits, i.e. free trade zone, tax free facilities, sales tax. Moreover, the existing infrastructure of petrol stations can be used for charging electric vehicles, rather than have separate stations that will increase the cost of the implementation of the electric vehicle project. Government can change policies of the vehicle industry. They can encourage electric vehicles by limiting the sale of petrol vehicles that create much noise and pollute the environment. Awareness programs with the climate ministry can be launched to help the public become aware of the damages caused by pollution to climate and health. Vehicle industry and relevant industries can be encouraged for playing their role in diminishing global warming by adopting renewable processes and for manufacturing their products by giving them tax relaxation if the emission level of CO2 is less than the target set by the government for industries. Punishment can be set for those who cross the limits of accepted emission levels of CO2. This type of policies will help in addressing climate change in Pakistan. Government can provide skills to the youth through training programs on the manufacturing of solar panels. Services of foreign trainers can be used to train students on this renewable project. Solar energy is in 342

G R E E N S U K U K F O R R E N E WA B L E P RO J E C T S

demand. Punjab, Balochistan KPK, and Sindh have the potential for solar and wind plants, which can be utilized for resolving the energy crises in Pakistan.

22.8 Limitations and future direction This study is qualitative in nature and describes the role of green sukuk in renewable projects in Pakistan. Interviews are only taken from mudarbah companies because of a lack of resources and time. A quantitative study can be conducted to explore the effects of green sukuk on energy crises and global warming. It can be made qualitative by taking interviews from all relevant governmental authorities and industries working on renewable projects.

22.9 Concluding remarks Green sukuk is similar to sukuk, which is investment that is only invested in green projects. Mudarbah companies and other investment companies have been avoiding investments in renewable projects due to the risk of losing money as government and policies are not very favorable for promoting such projects, i.e. harnessing wind and solar power, and using electrical vehicles. Government with the AEDB and FBR can invest money in green sukuk so that mudarbah companies can further invest in those companies that are working to create solar and wind plants and electric vehicles for resolving the global energy crises and global warming in Pakistan.

Appendix What does the holy book Qur’an say about riba?

It is essential for us to know that riba has been prohibited in the Holy Qur’an. 1

First revelation about riba in the Qur’an That which you give as interest to increase the peoples’ wealth increase not with God; but that which you give in charity, seeking the goodwill of God, multiplies manifold. (Surah Rome, Verse 39)

2

Second revelation about riba in the Qur’an And for their talking interest even though it was forbidden for them, and their wrongful appropriation of other people money, and we have prepared for those among them who rejected faith a grievous punishment. (Surah Al-Nisa, Verse 161) 343

M aryam S aeed

3

Third revelation about riba in the Qur’an Believers! Do not swallow Riba, double and redouble, and be mindful of Allah so that you, may attain true success. (Al Imran, Verse 130) These verses directly prohibited the riba and all arguments about interest.

4

Prohibition of riba in the hadith

The Holy Prophet (SAW) has also greatly emphasized on avoiding riba; some of his sayings are given below: 1

2 3

4 5

From Hazrat Jabir Ibn-e-Abdullah (RA): The Prophet, (SAW) cursed the receiver and payer of interest, the one who records it, and the witnesses to the transaction, and said: “they are all alike (in guilt)” (Muslim, Trimidhi, and Musnad Ahmed). From Hazrat Abu Haurayrah (RA): The Prophet, (SAW), said: “Riba has seventy segments, the least serious being equivalent to a man committing adultery with own mother,” (Ibn Majah) From Hazrat Amr Bin Al Aas (RA): “When interest-based dealing becomes common among people, they will start facing draught and shortage of food. And when bribery becomes norm among people, they will live under constant fear of their enemy”. From Hazrat Abu Hurayrah (RA): The Prophet (SAW), said: “There will certainly come a time for mankind when everyone will take Riba and if he does not do its dust will reach him” (Abu Dawud, Ibn Majah). Ibn Abi Usama (RA): The Prophet (SAW), said: “Every loan that draws any premium is Riba” (Musnad Ahmed).

To keep humanity in general and Muslim ummah in particular away from riba, this study explores the opportunities, challenges, problems, obstacles, and hindrances facing the Islamic banking industry in Pakistan for the issuance of the musawwamah card and reveals the proposed solutions in light of the respondents’ viewpoint along with our recommendations.

References Ahmed, T. J. (2019). An integrated approach for building sustainable Islamic social finance ecosystems. ISRA International Journal of Islamic Finance, 11(2), 246–266. Alam, N., Duygun, M., & Ariss, R. T. (2016). Green Sukuk: An Innovation in Islamic Capital Markets. In Dorsman, A., Arslan-Ayaydin, Ö., & Karan, M. B. (eds.), Energy and Finance (pp. 167–185). Cham: Springer. Ali, D. M., & Abdullah, D. S. (2017). Green Sukuk: Present State and Future Outlook. Available at https://iais.org.my/attach/2017/20NOV2017_GreenTech/ presentations/Session3_Speaker3_MahbubiAli.pdf.

344

G R E E N S U K U K F O R R E N E WA B L E P RO J E C T S

Ansari, I. (2011, May 8). Renewable energy FBR exempts equipment from tax. Pakistan: The Express Tribune. Available at https://tribune.com.pk/story/164089/ renewable-energy-fbr-exempts-equipment-from-tax/. Apnizan, A. (2019). Time for Malaysia to lead Islamic social finance endeavours. New Straits Times. Available at https://www.nst.com.my/opinion/columnists/ 2019/11/543461/time-malaysia-lead-islamic-social-finance-endeavours. Burnard, P. (1995). Interpreting text: an alternative to some current forms of textual analysis in qualitative research. Social Sciences and Health, 1, 236–245. Dalal, A., Mehmet, A., Mahmoud, M., & Tochukwu C. N. (2018). Green sukuk, energy poverty, and climate change: a roadmap for Sub-Saharan Africa. Policy Research Working Papers. World Bank Group. Available at https://doi. org/10.1596/1813-9450-8680. Ibrahim, M., & Ajayi, J. (2019). The role of Islamic social finance towards alleviating the humanitarian crises in North East Nigeria. Jurnal Perspektif Pembiayaan dan Pembangunan Daerah, 6(5), 545–558. Islamic Financial Services Board. (2018). Islamic Financial Services Stability. Retrieved from www.ifsb.org/sec03.php. Jamal, N. (2017, march 3). Nishat Group to Introduce Electric, Hybrid Cars. Lahore, Punjab, Pakistan: Dawn. Available at https://www.dawn.com/news/1318040. Jobst, A. (2018). Credit Risk Dynamics of Infrastructure Investment: Considerations for Financial Regulators (Report Version) (March 22, 2018). Available at SSRN: https://ssrn.com/abstract=3152977 or http://dx.doi.org/10.2139/ ssrn.3152977. Kumar, P., Srivastava, & Dhar, A. (2017). Role of electric vehicles in future road transport. In Gautam, D. S, Dhar, A., Gupta, J., & Pandey, A. (eds.), Sustainable Energy and Transportation. Energy, Environment, and Sustainability (pp. 43–60). Singapore: Springer. Laskowska, A. (2017). The green bond as a prospective instrument of the global debt market. Copernican Journal of Finance and Accounting, 6(4), 1–10. Mallick, D. S. (2016). Financial mechanism for renewable energy technologies – designing climate change investment bank for Pakistan. Journal of Social and Organizational Analysis, 2(1), 10–19. Morea, D., & Poggi, L. A. (2016). Islamic finance and renewable energy: an innovative model for the sustainability of investments. International Annual Conference (AEIT), 1–7. Available at http://dx.doi.org/10.23919/AEIT.2016.7892766. Outlook, G. E. (2016). Beyond One Million Electric Cars. International Energy Agency. Available at https://www.interregeurope.eu/fileadmin/user_upload/tx_ tevprojects/library/Global_EV_Outlook_2016.pdf. Patel, A. (2015). Channeling asset-managed sukuk towards SMEs financing: a case study for sukuk mudaraba (asset finance) applied to a French SME. European Journal of Islamic Finance, 1(2), 1–13. Patton, M. Q. (2002). Qualitative Research & Evaluation Methods: Integrating Theory and Practice. Thousand Oaks, CA: SAGE Publications. Qureshi, M. N. (2009). Energy Crisis In Pakistan: A Threat To National Security. ISSRA Papers, 72–104. Ramady, M. (2018). Not your average national oil company. In Saudi Aramco 2030 (pp. 25–59). London/Cham : Springer. Available at https://b-ok.cc/ book/3395305/524109.

345

M aryam S aeed

Saleem, M. A., Eagle, L., & Low, D. (2018). Climate change behaviors related to purchase and use of personal cars: development and validation of eco-socially conscious consumer behavior scale. Transportation Research Part D, 59, 68–85. Seikh, S., & Shan, S. (2010). Sukuk bond: the global Islamic financial instrument. Business Islamica, 1(11), 1–12. Silverman D. (2003). Doing Qualitative Research, 3rd ed. London: SAGE publication Ltd. Stern. (2006). Stern Review on the Economics of Climate Change. Suruhanjaya Sekuriti Securities Commission Malaysia. (2009). Retrieved from Suruhanjaya Sekuriti: www.sc.com. Subhi Y. L. (1969). Capitalism in medieval Islam. The Journal of Economic History, 29(1), 79–96. Tan Wan, Y. (2009). Sukuk: issues and the way forward. International Legal News. Available at http://www.iln.com/articles/pub_1674.pdf. Ullah, I. (2015). Islamic bonds (sukuk) in Malaysia. Islam and Civilisational Renewal, 489–508. Available at https://www.semanticscholar.org/paper/ ISLAMIC-BON DS - (%C3%98UKO%CC%83K) -IN-MALAYSIA-K han / c81e1991da104ac38c5b985b4daefaf8dcc61e8c. Ulrika, M. (2018). Unlocking islamic social finance to help communities address vulnerability and inequality. UNDP. Available at https://www.undp.org/content/ undp/en/home/news-centre/speeches/2018/Unlocking_Islamic_Social_Finance_ to_Help_Communities_Address_Vulnerability_and_Inequality.html. Vermeir, I., & Verbeke, W. (2006). Sustainable food consumption: exploring the consumer attitude-behavioral intention gap. Journal of Agricultural and Environmental Ethics, 19, 175. YoungMan, K., & Mohamad H. A. A. (2018). Research on Islamic green finance: understanding green sukuk with a case study of the Tadau Energy LSS project. New & Renewable Energy, 14, 20–21.

346

23 CONCLUSION ON CONTEMPORARY ISSUES IN ISLAMIC SOCIAL FINANCE Hussain M. Qadri and M. Ishaq Bhatti This chapter makes some concluding remarks on the contribution of this volume to the wider literature on contrary issues of Islamic social and financial aspects. This edited volume is a collection of selected chapters presented at the Third World Islamic Economics and Finance Conference (WIEFC), which was held during 25–26 January 2020 at Minhaj University, Lahore in Pakistan. The theme of this conference was ‘People Empowerment, Social Innovation and Role of Islamic Economics and Finance’. This volume begins with an introductory chapter by the editors and then followed by 22 chapters on various areas of Islamic social finance. It covers a wide range of fascinating topics in social finance, including capital structure on Islamic banking and finance (IBF) products, well-being tawhidi indices, risk management, social finance institutions’ performance, behavioural, charity, and wealth management, zakat, waqf, sustainable growth, halal marketing, and customer care, auditing and accounting reporting on the social aspects of IBF, Islamic insurance (takaful), and Islamic social bonds (sukuk), and credit- and musawwamah-card related issues in the IBF industry. Some case studies related to Islamic social finance are also presented. As the book contains the papers presented at an IBF conference in Pakistan as chapters, it includes more papers based on Pakistani experiences and lessons learnt from Pakistani IBF industry. The ramifications taken from such experiences and their relationships with the economies of other Islamic countries, including Malaysia, Indonesia, Saudi Arabia, Iran, and Nigeria are highly considered. One of the chapters in this collection is on the IBF experience in the United Kingdom. In this chapter, M. Amin elaborates on the Islamic banking practices in the UK. This chapter may be used as a guideline for IBF in non-Muslim countries where Muslims are a minority but Islamic social financial institutions like zakah (alms), khairat (charity), sadqat (donations), waqf (Islamic endowment), takaful (insurance), and social or green bonds (sukuk) are operating under the local taxation regime. For example, Bhatti (2015) explore the case of Australian taxation issues related to Islamic finance. Some of these products may be beneficial

DOI: 10.4324/9781003050209-23347

H ussain M . Q adri and M . I shaq B hatti

for Muslims for their financial inclusion and taxation benefits (Bhatti, 2020). Moreover, the current literature reveals that some new practical tools can be developed for banks and financial institutions to have sustainable Islamic social finance ecosystems (see Tahiri Jouti, 2019) and the use of financial technology based on Fintech, like waqf-fintech, waqf-crowd, and waqf-coin, which may equally be used in Muslim majority and minority countries.

References Bhatti, M. (2015). Taxation treatment of Islamic finance products in Australia. Deakin Law Review, 20, 263. Bhatti, M. (2020). Managing Shariah non-compliance risk via Islamic dispute resolution. Journal of Risk and Financial Management, 13(1), article 2, 1–9. Tahiri Jouti, A. (2019). An integrated approach for building sustainable Islamic social finance ecosystems. ISRA International Journal of Islamic Finance, 11(2), 246–266. https://doi.org/10.1108/IJIF-10-2018-0118.

348

INDEX

Note: Bold page numbers refer to tables; italic page numbers refer to figures. AAOFI see Auditing Organization for Islamic Financial Institutions (AAOFI) AAOIFI see Accounting and Auditing Organisation for Islamic Financial Institution (AAOIFI) ABC Islamic Bank of Bahrain: AL-BURAQ Islamic credit card 208 Abd Majid, M. S. 174, 178 Abduh, M. 171, 173, 174, 178 Abma, R. C. N. 172 Abu ‘Ubayd al-Qasim 241 Accounting and Auditing Organisation for Islamic Financial Institution (AAOIFI) 42, 236, 237, 331, 333; Financial Accounting Standard 9 (FAS 9) 237, 239; Shari’ah Board 44 Accounting for Zakat on Business 236, 237 ADIB (UK) Ltd 119, 122, 135–137, 136, 137, 145 AEDB see Alternative Energy Development Board (AEDB) Ahmed, A. 211 Ahmed, S. M. 172 Akhtar, S. 110, 112 Alam, I. 22 Al Baraka Bank Pakistan Limited 13 Al Barr, Ibn Abd 62 Al-Dharir, M. S. 193, 196–197 Al-Farisi, A. S. 12–13 Algan, Y. 63 Ali, M. 315 Allied Bank Limited 13 Alnaser, F. M. I. 313, 314, 318, 324 Al-Oqool, M. A. 174

Al Rahahleh, N. 173 Al Rajhi, A. 174 Al Rajhi Academy 47–48 Al Rajhi Bank 37, 47 Al Rajhi Group 48 Al-Suwailem, S. 65 Al-Tabari, A. J. M. 235 Alternative Energy Development Board (AEDB) 337 Alzafiri, E. 12, 15, 17, 20 amanah 42, 208, 210 AMA see American Marketing Association (AMA) Amazon 100 AM Bank of Malaysia: AL-TASLIF Card 208 American Marketing Association (AMA) 101 Amin, M. 315 Anderlini, L. 57 Anderson, E. W. 315 Angur, M. G. 314 Ansari, M. I. 172 Anwar, M. 110–111 ‘aqd 25, 30 Aqil, M. 110 ARDL see auto regressive distributed lag (ARDL) Arslan, M. 110 Ashraf, D. 15, 22n1 asset-backed financing 158, 160–162, 166, 169, 173 asset concentration 147 assistance for orphans and needy 189 Asutay, M. 174

349

INDEX

Auditing Organization for Islamic Financial Institutions (AAOFI) 197 auto regressive distributed lag (ARDL) 173 Ayub, M. 173 Azmi Omar, M. 171, 173, 174, 178 Bagehot, W. 172 Bangake, C. 172 Banking School Theory 80 BankIslami Pakistan Limited 13 Bank Negara Malaysia (BNM) 234, 235 Bank of England 123 Bank of London and the Middle East Plc (BLME) 125–127, 126, 140, 148 Bank of Punjab 337 Bank Rakyat 208 Basel II Accords 15 Basel III Accords 40, 47 Bashir, A.-H. M. 173 Battaglia, D. 58 Battour, M. 294 BAZNAS 337 beauty: products 92–94; symbols of 90, 92 Beck, U. 64 Berger, A. N. 12 Bernholz, P. 82 Bhatti, M. 347–348 BLME see Bank of London and the Middle East Plc (BLME) BNM see Bank Negara Malaysia (BNM) Brantlinger, P. 59 Burj Bank Limited 11, 13 business zakat reporting 234–244; assets and liabilities, measurement of 242; case studies 241; for Islamic financial institutions 236–237; measurement of 238; presentation and disclosure 238–241, 240, 242–243, 243; recognition of 238; recognition on zakat expenses 241 Cahuc, P. 63 CAIR see Council on American-Islamic Relations (CAIR) Capital Asset Pricing Model (CAPM) 14, 21 CAPM see Capital Asset Pricing Model (CAPM) CBI see Climate Bonds Initiative (CBI)

CCBI see climate change investment bank (CCBI) Centre Management Committees (CMCs) 109 CFA see charity fund account (CFA) Chapra, U. 193 charity fund account (CFA) 193–205; analysis 202–203; late-payment charges, SBP regulation for 197–198; penalty on delayed payments, charging 196–197; in Quran and Sunnah 195–196; recommendations for 203–205; research methodology 194–195; shari’ah screening criteria, for Islamic banks: accepted limit of non-compliant investments to total assets 198; interest-bearing debt to total assets, incidence of 198; investee company, nature of business of 198; non-compliant income to total revenue, tolerance level of 198; sources and uses of 198, 199–202; statement of disbursement 202 Che-Mat. A. 212 Choo, S. Y. 212 Christian Corporate Culture 98 Chu, J. Y. 59 Clean Energy Business Council of the Middle East and North Africa (MENA) 332 Climate Bonds Initiative (CBI) 332 climate change investment bank (CCBI) 335 CMCs see Centre Management Committees (CMCs) Codex Alimentarius Commission 275 collectivism vs individualism 97–100 Comrey, A. L. 327 Corporate Social Responsibility (CSR) 98, 247–249, 258 Cost Channel of Monetary Transmission 73, 80 Council on American-Islamic Relations (CAIR) 99 Covallo, D. F. 77 credit: card 207–223; in conventional literature 56–60; micro-credit 57; risk 37–38, 47, 48 Crescent Rating 294 CSR see Corporate Social Responsibility (CSR)

350

INDEX

cultural transformation, channels of 89–96, 91; beauty products 92–94; fashion 94–96; symbols of beauty 90, 92 Currency School Theory 80 customer satisfaction, service quality and 314–316; mediating role of customer satisfaction between 317, 318 Dali, N. R. S. M. 212 DARAZ 222 David, R. 57 debt: bad 59; in conventional literature 56–60; domestic public 72, 73; intergenerational 58; in Islamic moral economy 60–62, 64–66; micro-debt 57; repayment 61, 73; short-term 73, 81 Deehani, T. A. 11–14, 17, 20, 21 Demetriades, P. O. 172 deposits: impact of: on cost of equity 20; on earnings per share 18, 20; on market value 18, 19 development and organizational behavior, spirituality indices of 31–32 Dewitt, B. 31 Dhankar, R. S. 171, 173, 174, 178 digital era, ethical edges for marketers in 100–101 Di Patti, E. B. 12 displaced commercial risk 22n2 Dollar, D. 172 Dubai Islamic Bank Pakistan Limited 13, 37, 47, 214, 218, 220, 221 Dunn, E. C. 57 Durrenberger, E. P. 60 Durusu-Ciftci, D. 172 earnings per share, impact of deposits on 18, 20 econometric methodology 175–176 economic growth, Islamic banking and 169–181; data and methodology: econometric methodology 175–176; model specification 176, 176; economic growth 171–175; recommendations 180–181, 181; results: descriptive analysis 176–177, 177; Granger causality analysis 179–180, 180; ordinary least squares method 178–179; unit root analysis 178

economic value proposition of Islamic finance 152–153 educating youth on halal food audit and certification 281 Eggoh, J. C. 172 EIIB see European Islamic Investment Bank plc (EIIB) (now Rasmala UK Ltd) Ekimova, K. 171, 172 El-Gamal, M. 173 El-Gari, A. 196 Endogenous Growth Model 163 Eoncap Islamic Bank Berhad: Ujrah model 208 equity 2, 10–15, 21, 22, 46, 125, 127, 128, 131, 132, 135, 149, 153, 154, 157, 160, 163, 164, 166, 167, 169, 238, 239, 242, 335; -based finance 121, 167; capital 12, 15, 121, 148; cost, impact of deposits on 20; participation risk 121; ratio 13 Ergeç, E. H. 174 European Islamic Investment Bank plc (EIIB) (now Rasmala UK Ltd) 123–125, 124, 125, 145, 148 Evans, C. 171 Fase, M. M. 172 fashion 94–96 FBR see Federal Board of Revenue (FBR) FDI see foreign direct investment (FDI) Federal Board of Revenue (FBR) 337 Finance Act 2005 (UK) 123, 149n3 financial crisis of 2007 169 Financial Services Act 2013 (FSA) 234 financial inclusion 1, 160, 169, 170, 174, 178 Fintech 348 fiqh 24, 26, 29, 50, 67, 226 foreign direct investment (FDI) 75, 265 foreign exchange reserves 75–76, 76 Franklin National Bank 208 FSA see Financial Services Act 2013 (FSA) Furqani, H. 171, 173, 174, 178 Gatehouse Bank plc 127–128, 129 Ghaffari, A. 79 Ghuddah, A. S. A. 197 Gibson, A. H. 73, 77, 80 Global Financial Crisis of 2007 78

351

INDEX

Global Islamic Finance Report 2018 158 Global Muslim Travel Index (GMTI) 294, 295 GMP see good manufacturing practices (GMP) GMTI see Global Muslim Travel Index (GMTI) Gold Standards System 82 good manufacturing practices (GMP) 279 Granger causality analysis 175, 179–180, 180 Granger, C. W. 175 Greek Cypriot Bank 315 green sukuk, for financing renewable projects 331–344; conceptual framework 337–339, 338; future direction 343; limitations 343; literature review: electric vehicle 336; Islamic social finance 336–337; solar and wind 334–335; recommendation 342–343; research methodology 339– 340; results/findings: dependence on foreign technology 341; high risk 340; lack of a regulatory body 341; lack of commitment 341; lack of government support 340; lack of infrastructure 341; lack of investment 340; lack of public awareness 341; local solar manufacturing, infancy phase of 341; net metering 341; technical issues 341 Gregersen, N. H. 60, 64 Gregory, C. A. 56–57, 59 Gropp, R. 12 Growth Model 163 Gudeman, S. F. 57 Guha, R. 57 Gulf Bond & Association 332 Gulf Cooperation Council 334 Habib Bank Limited 13, 337 HACCP see Hazard Analysis and Critical Control Points (HACCP) Haider, A. 110, 112 halal education: for consumers 286; Muslim consumers 287; non-Muslim consumers 287; for halal consultants and auditors 287–288; on halal logistics and supply chain 288, 288; for workforce in halal industry 287 halal industry 273–289; audit and certification 278–281, 279, 280;

challenges to 281; educating youth on halal food audit and certification 281; education see halal education; global Muslim population 276, 278; investment 180; history of 264–266; lack of academic programs on 282, 283; lack of collaboration and interoperability among halal certification bodies 285; lack of training of staff at the workplace 282–284; limited knowledgeable workforce in 285–286; logo, manipulation of 284–285; segment demystification 274–276, 275, 277 Halal Industry Development Corporation (HDC) 265 halal market, growth of 266–268; global competition, increasing 267; institutional support 268; investments 268; product diversity, increasing demand for 268; standard 268 halal products and services: demand for 260–271; food 262; importance of 268–269; international convention, need for 269–270; pharmaceutical and health products 262–263; tourism 263–264 halal professionals, job areas/ opportunities for 289 Halal Research Council 268 halal tourism 263–264; definition of 294; destinations 295; factors affecting 294; framework of 293; in Indonesia 293–309 Hamid, H. A. 212 Hammad, N. 193, 196 hanafi schools 24 hanbali schools 24 Han, H. 316, 324 Haque, N. 157 Harrod–Domar Model 163 Hasan, Z. 161 Hazard Analysis and Critical Control Points (HACCP) 279 HDC see Halal Industry Development Corporation (HDC) health assistance to the sick and needy 188–190; accommodations, provisions and renovation of 189–190; assistance for orphans and needy 189; monthly allowances for people with disabilities 189; Ramadan packages for orphans

352

INDEX

and needy 189; yearly zakat collection and distribution at district level 190 Heider, F. 12 Heinemann, T. 57 Hendrawan, R. 12–13 Herwartz, H. 172 Hicks, J. 172 hijab 94–96 Hofstede, G. 97 hope vs expectations 63 HSBC: Amanah-based model 208 Human Development Index 31–32 Hussein, K. A. 172 Hyundai Motor Company 339 IASB see International Accounting Standard Board (IASB) IBB see Islamic Bank of Britain plc (IBB) (now Al Rayan Bank plc) IFIs see Islamic financial institutions (IFIs) IFRS see International Financial Reporting Standards (IFRS) IFSA see Islamic Financial Services Act 2013 (IFSA) IFSB see Islamic Financial Services Board (IFSB) ihsan 55, 62, 66, 67n4 Ihsan Trust 203 ijarah 39, 45, 164, 333 inclusive economic growth, Islamic finance and 160–163, 161, 162, 171, 172 INDCs see intended nationally determined contributions (INDCs) individualism vs collectivism 97–100 Indonesia, halal tourism in 293–309; data analysis techniques: coefficient determination 298; correlation test 297–298; hypothesis test 298–299; methodology: documentation 297; questionnaire 297; Ministry of Tourism, mission of 300; Ministry of Tourism, vision of 299; policy 308–309; practice 309; prior study 296, 296, 297; research instrument results: economic growth 306–307; innovative activities 306; reliability test 305, 305, 306; strategic goals 307–308; test validity 304–305, 305; respondent profiles, characteristics of 300–301, 301; respondents based on hobbies

303–304, 303, 304, 304; respondents based on latest education 301; respondents based on their parents’ work 302, 302 infaq 162 inflation: in heavily indebted countries 80–81; and interest rate, positive association between 79–81; rate, high 83; reduction by interest rate reduction 84; reduction, monetary policy and 76–79, 77, 78, 78, 79 Inflation Targeting Framework 74 innovation in Islamic social finance instruments 29, 100, 212, 293 intended nationally determined contributions (INDCs) 335 interest-free asset market, flow of funds in 153–157, 154–156 interest rate: in heavily indebted countries 80–81; and inflation, positive association between 79–81; reduction, inflation reduction by 84 intergenerational debt 58 International Accounting Standard Board (IASB) 236, 237 International Financial Reporting Standards (IFRS) 237 International Labour Organization 107 Investment Dar of Kuwait 45 Irfan, M. 109 Isa, M. 187 Isa, Z. 315 Ishaq, E. 193 Islamic Bank of Britain plc (IBB) (now Al Rayan Bank plc) 131–135, 132, 145–149; sukuk, buying 134–135; sukuk issue 133; sukuk issuing benefits 133–134 Islamic Development Bank 166 Islamic financial institutions (IFIs) 234–236, 241–244; business zakat reporting for 236–237 Islamic Financial Services Act 2013 (IFSA) 234 Islamic Financial Services Board (IFSB) 37, 48 Islamic micro-finance 116 Islamic mutual funds 15, 169, 170, 181 Islamic social finance: contemporary issues in 1–9, 347–348; green sukuk and 336–337; risk management and

353

INDEX

sharing in 36–50; see also individual entries Islamic spirituality index 30–31 Ismail, A. G. 12 Ismail, M. N. 294 istisna sukuk 334 JAKIM see Malaysian Islamic Development Department (JAKIM) Jedidia, K. B. 172 job creation 107–117; literature review 110–111; model: background of 111– 112; details of 112–115, 114; proposed model vs current models 115–116 justice 55, 60, 62, 64, 66, 67n4, 68n7, 164, 211; distributive 150, 151; socioeconomic 1, 97, 267 Karachi Stock Exchange (KSE) 11, 13 Kassim, S. 174, 178 Keynes, J. M. 77, 80, 150 khairat (charity) 1 Khaldun, I. 36 khalifa (vice-regency) 98 Khan, M. 286 khilafah 164 khums 161 Kishk, Sheikh ‘Abd al-Hamid 62 Kraay, A. 172 KSE 100 index 21 KSE see Karachi Stock Exchange (KSE) Kusuma, D. B. W. 171, 174, 178 Kuznets, S. 166 Kwon H. 59 Labour Force Survey of 2003–2004 110 Labour Force Survey of 2017–2018 108 Lahsasna, A. 48 Lapin, R. D. 87–88 late-payment charges, SBP regulation for 197–198 Lee, H. B. 318 Lee, Y. 57 Levesque, T. 315, 319 Levine, R. 172 L’evi-Strauss, C. 58 Lewis, W. A. 166 Leyshon, A. 59 Li, H. 172 liquidity risk 39–41 Lloyds Banking Group PLC 132

loan 37, 44, 45, 56–62, 65, 116, 117, 145, 150, 151, 152, 160, 167, 173, 196, 335; family 59, 60; fixed rate 120; institutional 59; interest-free (qard e hasana) 9, 10, 13, 18, 20, 21, 38, 40, 154, 162, 164, 166 loyalty behavior, service quality and 316 Luhmann, N. 63 Luqman, S. 64 MacDonald, G. 58 macroeconomic risk 42–44 Maidoki, M. L. 187 Maison, D. 284 Majma’ Fiqh al-Islami (Islamic Fiqh Academy) 196 Malaysian Accounting Standard Board (MASB) 236, 237 Malaysian Al-Taslif card 210 Malaysian Financial Reporting Standards (MFRS) 234 Malaysian International Halal Showcase (MIHAS) 265 Malaysian Islamic Development Department (JAKIM) 238, 241, 265 Malhotra, N. K. 313 Malik, M. R. 120 Malinowski, B. 56, 57 Mansor, F. 169 Mansor, N. 212 maqasid al-shari’ah 273 maqasid as-shari’ah 25 maqasid-e-shari’ah 163–164 marketing, influence of religion on 87–89 market value, impact of deposits on 18, 19 markup payments 81 MASB see Malaysian Accounting Standard Board (MASB) Masraf Al Rayan 133, 145 Maurer, B. 58–59 Mauss, M. 56–58 Maybank Group 48 Maybank Islamic of Malaysia 37, 48 MCB Islamic Bank 215, 218–219, 221 MCB Mudarbah Company 339 McCallum Rule 74 McDougall, G. H. G. 315, 319 Meezan Bank Limited 13, 37, 48, 213, 214, 217–218, 220 Meyer, L. H. 74

354

INDEX

MFRS see Malaysian Financial Reporting Standards (MFRS) micro-credit 57 micro-debt 57 MIHAS see Malaysian International Halal Showcase (MIHAS) Miller, M. H. 12 Ministry of International Trade and Industry (MITI) 265 Ministry of Labour and Manpower for the Ninth Five Year Plan (1998–2003) 107–108 Minsky, H. P. 58, 67n2 Mirakhor, A. 157 MITI see Ministry of International Trade and Industry (MITI) Modern Monetary Theory 82 modesty 94, 95 Modigliani, F. 12 Mohieldin, M. 173 monthly allowances for people with disabilities 189 Moody’s Analytics 48 moral hazard 38–39, 58, 113, 114, 160 Mubarik, M. S. 110 mudarabah 10–13, 17, 20, 21, 46, 153, 333, 337 mudarib 10, 11, 14, 22n2, 45, 333 Mulyany, R. 171, 173, 174, 178 Muqorobin, M. 171, 174, 178 murabahah 39–45, 332–334, 338s musawwamah-based card 207–223; conditions for 209; experts’ opinions and judgments 213–221; history of 208–209; literature review 210–212; recommendations for 223; tools and methods 212 musharakah 153, 334 Muslim Commercial Bank 13 National Bank of Pakistan 13 National Vocational and Technical Training commission (NAVTTC) 109 National Youth Development Framework (NYDF) 108 NAVTTC see National Vocational and Technical Training commission (NAVTTC) NBP Modaraba Management Company 339 Nelson, B. 60 neoclassical economics 107

Netflix 100 Nishat Group 339 Noble Eightfold path 88 NYDF see National Youth Development Framework (NYDF) OIC see Organization of Islamic Cooperation (OIC) Oliver, R. L. 314–315 Olmo, B. T. 171, 172 OLS see ordinary least squares (OLS) method Omar, A. 2 operational risk, control of 41–42 ordinary least squares (OLS) method 178–179 Organization of Islamic Cooperation (OIC) 265, 270 Pakistan Environmental Protection Agency 338 PAKSERV model 313, 314, 316, 318, 324–326 Palsson, G. 60 Papataxiarchis, E. 59 Parasuraman, A. 314 Peebles, G. 59 Pellegrina, L. D. 12 penalty on delayed payments, charging 196–197 PEW Research Centre 1 pharmaceutical and health products 262–263 Pietz, W. 59 Piketty, T. 166 Polanyi, K. 56 policy rate 72–84; borrowing and 81–83; and foreign exchange reserves 75–76, 76; and inflation reduction 76–79, 77, 78, 78, 79; interest rate and inflation, positive association between 79–81; markup payments and 81; rise of 74–75; and tax inflation channel 81 poverty 246; alleviation 186, 187, 190; role of zakat in addressing 185–192; health assistance to the sick and needy 188–190; literature review 186–187; research methodology 188; results 188; theoretical framework 187 Pratomo, W. A. 12 Pre-Higher Education Program 246–258; literature review 248–250;

355

INDEX

methodology 250–253; campuses and student’s distributions 252, 253, 254, 256; parameters 251, 251–252; pillars of 255; study aims 248 “Prime Minister’s Kamyab Jawan Programme” 108 profit-sharing investment (PSI): accounts on capital structure of Islamic banks, implications of 10–22; data sources and methodology 13–15; descriptive statistics 15–17, 16, 17; empirical estimations 18–20, 19; literature review 12–13; model specification 14–15 PSI see profit-sharing investment (PSI) Punjab Vocational Training Council (PVTC) 109 PVTC see Punjab Vocational Training Council (PVTC) qard-al-hasan 10 qard-e-hasana (interest-free loan) 9, 10, 13, 18, 20, 21, 38, 40, 154, 162, 164, 166 qarz-e-hasanah 223 QIB (UK) plc 128, 130, 131, 145 quality services 312–326, 320–322; literature review and hypothesis development 313–318; service quality and customer satisfaction 314–316; service quality and loyalty behavior 316; service quality and loyalty behavior, mediating role of customer satisfaction between 317, 318; research methodology: sample size 318; survey instruments 318–319; structural equation modeling 322–325, 323, 324, 324 Quran: charity in 195–196; waqf in 227 Raajpoot, N. 313, 314, 318, 321, 324, 325 rabb al-mal 10, 11 Ramadan packages for orphans and needy 189 Rammal, H. G. 173 Raza, S. A. 315 recent developments in Islamic social finance 333–334 Rehman, A. U. 73, 79, 83 religion, influence on marketing 87–89 religiosity 3, 90

Rescher, N. 63 riba (usuru/interest)1, 10, 11, 38, 43, 97, 150, 151, 164, 173, 196, 207–209, 211, 223n6, 312, 343–344 risk 63–64; credit 37–38, 47, 48; in Islamic moral economy 64–66; liquidity 39–41; macroeconomic 42–44; management practice 47–49, 47, 48; mitigation 45–46; operational, control of 41–42; shari’ah 44–45; sharing 36–50, 169, 211; society 64 Robinson, J. 172 Ryu, K. 316, 324 Sabourian, H. 57 sadqah 211 sadqat (donations) 1, 347 Sahlins, M. 58, 59 Sakti, M. R. P. 12 salam sukuk 334 Sani, U. B. 187 Sarwar, N. 110 SBP see State Bank of Pakistan (SBP) Schumpeter, J. A. 172, 174 SDGs see Sustainable Development Goals (SDGs) Seifzadeh, P. 22 SEM see structural equation modeling (SEM) service quality: and customer satisfaction 314–316; mediating role of customer satisfaction between 317, 318; and loyalty behavior 316 SERVQUAL model 313–315 shafi’i schools 24 Shahnaz, L. 110, 112 shari’ah 10, 11, 24, 25, 209, 236, 262, 273; -based indices 29–30; risk 44–45; screening criteria, for Islamic banks: accepted limit of non-compliant investments to total assets 198; interest-bearing debt to total assets, incidence of 198; investee company, nature of business of 198; noncompliant income to total revenue, tolerance level of 198; shari’ahcompliant 5, 7, 36, 40, 43, 44, 48, 55, 66, 67, 119, 120, 122, 123, 140, 141, 143, 145–146, 171, 193, 198, 207, 210, 237, 331, 332, 334, 336; shari’ahcompliant instruments 335

356

INDEX

Shari’ah Advisory Board or Committee 235, 236 Shari’ah Council of Accounting 197 Shari’ah Governance Framework 236 Sharp, L. A. 59 Sharpe, W. F. 14 Shia Islam: individualism vs collectivism 97 shi’i schools 24 short-term debt 73, 81 short-term financing/investments, Islamic banking for 157–160, 158, 159 Shubber, K. 12, 15, 17, 20 sila-i-rahmi 66 Silverman D. 340 Sims, C. 77, 81 SME Leasing Company 337, 339 Sneath, D. 58 social well-being socially responsible investment (SRI) 334 Sokoto State Zakat and Endowment (Awqaf) Commission 185–192, 229–230 Song, J. 59 special purpose vehicle (SPV) 333–334 SPV see special purpose vehicle (SPV) SRI see socially responsible investment (SRI) Standard Chartered Bank (SCB): SAADIQ credit card 209, 214 State Bank of Pakistan (SBP) 13, 15, 37, 335; charity fund account 193–205; Monetary Policy Committee 75; policy rate in Pakistan’s economy, role of 72–84; borrowing 81–83; foreign exchange reserves 75–76, 76; high interest rate and inflation 83; inflation reduction 76–79, 77, 78, 78, 79; inflation reduction by interest rate reduction 84; interest rate and inflation, positive association between 79–81; markup payments 81; rise 74–75; tax inflation channel 81; regulation, for late-payment charges 197–198 State Bank of Pakistan Act 1956 74 State Islamic Religious Council 237 Stolbov, M. 173 Strathern, M. 58 structural equation modeling (SEM) 323–325, 323, 324, 324

sukuk 1, 41, 43, 44, 121, 122, 132, 145, 163, 164, 166, 170; background of 333–334; green 8, 331–344, issue in Al Rayan Bank plc 133–135; recent development 333–334; short-term 40 sunnah 24, 26, 27, 30, 55, 60, 185; charity in 195–196; waqf in 227 Sunni Islam: individualism vs collectivism 97 sunni schools 24 supply-leading theory 174 Sustainable Development Goals (SDGs) 171, 180, 181, 337; use of Islamic Finance in 165 sustainable economic growth, Islamic finance and 163–167 Tabash, M. I. 171, 173, 174, 178 takaful (insurance) 1, 151, 337, 347 tawhid index 24–34; conceptual and quantitative forms of 32–34; development and organizational behavior 31–32; Islamic spirituality index 30–31; as primal ontological law: Shari’ah-based indices 29–30; well-being indicators 26–29; as universal law 25–26 tax inflation channel 81 Taylor Rule 74 Thomson Reuters Global Islamic Finance Report 2018 158 Thrift, N. 59 Tooke, T. 80 Trautmann, T. R. 57 UiTM see University Technology MARA (UiTM) UK’s Islamic banking 119–149; ADIB (UK) Ltd 135–137, 136, 137; avoid lending on economically profit-sharing terms 120–121; Bank of London and the Middle East Plc 125–127, 126; development, government’s supportiveness for: domestic Islamic business, potential for 140; poor Muslims 142; retail market size and limiting factors 140–141, 140, 140; young Muslims 142; English legal system 138–139; European Islamic Investment Bank plc (now Rasmala UK Ltd) 123–125, 124, 125; financial results 137, 138; future

357

INDEX

risks: asset concentration 147; impact of departure from the EU 147–148; Gatehouse Bank plc 127–128, 129; general attractiveness of 137; historical overview of: industry 122; regulation 122; tax system 122–123; Islamic Bank of Britain plc (now Al Rayan Bank plc) 131–135, 132; sukuk, buying 134–135; sukuk issue 133; sukuk issuing benefits 133–134; political stability 138; poor execution 148; poor planning 148; professional resources and network effect 139; QIB (UK) plc 128, 130, 131; terminology 119–120; travel and time zone 139; willing to use conventional banking: adverse selection, risk of 145; Al Rayan Bank 146–147; corporate banks 146; diseconomies of being small 144; expensiveness 142–143; general environment 143–144; loss 143; management instability, impact of 144; religious objection 143; shari’ah compliance 145–146; strategic inconsistency 145 Umar, I. 185 ummah 55, 97–99, 185, 209, 211, 226, 232, 344 UNDP see United Nations Development Program (UNDP) unemployment 107, 108, 110, 111, 115, 116, 232 United Bank Limited 13 United Nations Development Program (UNDP) 31 unit root analysis 178 University Technology MARA (UiTM) 247–258 ushr 161 Usmani, M. A. 49 Usmani, T. 193 Verdery, K. 58

WACC see weighted average cost of capital (WACC) Walle, Y. M. 172 waqf (Islamic endowment) 1, 151–152, 161, 164, 166, 167, 188, 211; beneficiaries 230–231; challenges to 231–232; definition of 226–227; divisions of 228–229; in historical perspective 229; impact on Sokoto State peoples 231; Islamic rulings on 227–228; properties 230; in Qur’an and Sunnah 227; recommendations for 232; socio-economic impact of 226–233; Sokoto State Zakat and Endowment (Awqaf) Commission 229–230 weighted average cost of capital (WACC) 12, 20 WHF see World Halal Forum (WHF) WIEFC see World Islamic Economics and Finance Conference (WIEFC) Wilson, R. 173 World Halal Forum (WHF) 265 World Islamic Economics and Finance Conference (WIEFC) 1–2 Yieh, K. 316 Young’s World Islamic Banking Competitiveness Report 2013 170 zakah (alms) 1, 191n22, 197, 347 zakat (almsgiving) 97, 161–164, 166, 167, 211; benefits of 186; business reporting 234–244; recipients 186; refusal, severe warning for 186; role in addressing poverty 185–192; health assistance to the sick and needy 188–190; literature review 186–187; research methodology 188; results 188; theoretical framework 187 Zaman, A. 193 Zaman, R. 110

358