Islamic Finance and Sustainable Development: A Sustainable Economic Framework for Muslim and Non-Muslim Countries 3030760154, 9783030760151

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Edited by M. Kabir Hassan · Mehmet Saraç · Ashraf Khan

Islamic Finance and Sustainable Development A Sustainable Economic Framework for Muslim and Non-Muslim Countries

Islamic Finance and Sustainable Development

M. Kabir Hassan · Mehmet Saraç · Ashraf Khan Editors

Islamic Finance and Sustainable Development A Sustainable Economic Framework for Muslim and Non-Muslim Countries

Editors M. Kabir Hassan Department of Economics and Finance University of New Orleans New Orleans, LA, USA

Mehmet Saraç Faculty of Economics Department of Business Administration Istanbul University Istanbul, Turkey

Ashraf Khan Institute of Business Administration Karachi Karachi, Pakistan

ISBN 978-3-030-76015-1 ISBN 978-3-030-76016-8 (eBook) https://doi.org/10.1007/978-3-030-76016-8 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

We dedicate our book to the loving memories of our mothers, who have nurtured us, prayed for us, stood behind us during all good and bad times, and taught us how to stand high on our own feet until their death. Rest in peace.

Foreword

During 2015 summit, the UN agencies and the development community successfully launched the 17 Sustainable Development Goals (SDGs), with 36 topics and 169 targets to be achieved by 2030. The goals revolve around contemporary global characteristics such as resource allocation/use/depletion, pathogen mutations/remedies, globalization, urbanization, demographic shifts, technological revolution, inflation, and climate change. With many current and pending issues arising out of this, global leaders join hands to practice economic, social, ecological, and human sustainability. Academics have focused new research calculating strategies, designing plans, organizing data, budgeting and forecasting finances, and measuring metrics; this has provided guidance to governments, regulators, and public and private sectors around the world to meet this general mission. Islamic finance is currently a significantly sized and rapidly growing industry (3 trillion USD industry in over 110 countries). The development aspect of Islamic finance aligns well with the mission of global development and the coordinated planning in the recent decade resemble execution recommendations of SDGS. This book provides a comprehensive discussion to understand the important link between Islamic Finance and the SDGs and will be a reference point for policymakers and academic community who are concerned about environmental, social, and economic sustainability. The current

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FOREWORD

pandemic has brought the whole business and financial world at crossroads regardless of business model or industry. The present obstacles are coupled with long-term uncertainty which can exhibit slowing of SDG execution. The cohesive mission in Islamic finance theory resembles the proper mindset the world must undertake to combat the pandemic’s effects. Islamic finance prohibits interest and bases itself on mutual risk sharing; it is designed to create equity in social, economic, and ecological aspects of society. It does so with innovative instruments such as Zakat (committed charity), Sadakah (charitable donation), and Waqf funds (endowments). The field has grown due to the success of the instruments and further developments. In mind of SDGs, the editors have collected an array of chapters from international academic community, with focus to understand the alignment of Maqasid Al-Shariah with SDGs and current Islamic financial institution practices in achieving SDGs. It is essential to mention that there is strong convergence between Maqasid Al-Shariah and SDGs. In this regard, this book identifies new opportunities through innovative instruments and models to implement SDGs, not only in Muslim countries but also in non-Muslim countries. It gives me immense pleasure writing this foreword and I sincerely hope that this book will provide new insight on the applicable practice of Islamic finance theory to United Nations members, regulators, government officials, academics, private and public organizations, and any other stakeholders around the world. Ishrat Husain Former Governor of State Bank of Pakistan Chairman, Center for Excellence in Islamic Finance, IBA, Karachi, Pakistan

Contents

1

Introduction M. Kabir Hassan, Mehmet Saraç, and Ashraf Khan

1

Part I Islamic Finance and Sustainable Development Goals: Two Sides of the Same Coin 2

3

Need to Redefine Islamic Finance in the Light of Maqasid Al-Shariah M. Kabir Hassan, Aishath Muneeza, and Mehmet Saraç Pandemic Crisis, Digitalization and Social Responsibility: An Emerging Role of Islamic Economics and Finance M. Kabir Hassan, Aishath Muneeza, and Ashraf Khan

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35

4

Islamic Finance and SDGs: Connecting Dots Irum Saba, Ashraf Khan, and Haneeah Jawed

55

5

Islamic Finance: A Literature Review M. Kabir Hassan, Ashraf Khan, and Andrea Paltrinieri

77

6

The Role of Islamic Finance in Achieving Sustainable Development Goals (SDGs) Mohamad Akram Laldin and Fares Djafri

107

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x

7

8

CONTENTS

Islamic Finance and SDG 10: Evidence from Selected OIC Countries Hylmun Izhar and Murat Munkin

127

The Role of Islamic Financial System in Building Sustainable Infrastructure Zahid ur Rehman Khokher

151

Part II 9

10

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Sustainable Finance and a Shar¯ı’ Analysis of Environmental, Social and Governance (ESG) Criteria Aminudin Ma’ruf, Ziyaad Mahomed, and Shamsher Mohamad

193

Finance as a Source of Ecological Quality: Islamic Ethics of Environment and Empirical Evidence Muhammad Tariq Majeed

219

Islamic Finance and Sustainable Economy: A New Model of Islamic Financial Ecosystem Sutan Emir Hidayat, Yodi Izharivan, and Citra Atrina Sari

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Islamic Finance System as a Catalyst for Sustainability in the Economy Muhammet Yurtseven, Kamola Bayram, and Tawfik Azrak

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Part III 13

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Islamic Finance and Factors of Environmental, Social and Governance (ESG)

Islamic Financial Institutions and Sustainable Development

Qard Hasan (Interest-Free Loan) as a Tool for Sustainable Development—Global Evidence Rashedul Hasan, M. Kabir Hassan, and Mamun Rashid Contribution of Islamic Banks on Financial and Economic Stability: An Empirical Comparison Between Conventional and Islamic Banks Selim Kayhan and Tayfur Bayat

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CONTENTS

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Proposing New Islamic Microfinance Model for Sustainable Islamic Microfinance Institution Ascarya and Ali Sakti

Index

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349

379

List of Contributors

Ascarya University of Darussalam Gontor, Kabupaten Ponorogo, Indonesia; Bank Indonesia Institute, Bank Indonesia, Jakarta, Indonesia Tawfik Azrak Social Sciences University of Ankara, Ankara, Turkey Tayfur Bayat Department of Economics, Inonu University, Malatya, Turkey Kamola Bayram KTO Karatay University, Konya, Turkey Fares Djafri International Shari’ah Research Academy for Islamic Finance (ISRA), INCEIF University, Kuala Lumpur, Malaysia Rashedul Hasan Lecturer in Accounting, School of Economics, Finance and Accounting, Coventry University, Coventry, United Kingdom M. Kabir Hassan Department of Economics and Finance, University of New Orleans, New Orleans, LA, USA Sutan Emir Hidayat National Committee for Islamic Economy and Finance (KNEKS), Gunadarma University, Jakarta, Indonesia Hylmun Izhar Islamic Development Bank Group, Jeddah, Saudi Arabia Yodi Izharivan National Committee for Islamic Economy and Finance (KNEKS), Jakarta, Indonesia

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LIST OF CONTRIBUTORS

Haneeah Jawed Institute of Business Administration (IBA), Karachi, Pakistan Selim Kayhan Department of Economics, Necmettin Erbakan University, Konya, Turkey Ashraf Khan Institute of Business Administration, Karachi, Pakistan Zahid ur Rehman Khokher Islamic Banking Department, Central Bank of Oman, Muscat, Oman Mohamad Akram Laldin International Shari’ah Research Academy for Islamic Finance (ISRA), INCEIF University, Kuala Lumpur, Malaysia Aminudin Ma’ruf INCEIF, Kuala Lumpur, Malaysia Ziyaad Mahomed INCEIF, Kuala Lumpur, Malaysia Muhammad Tariq Majeed School University, Islamabad, Pakistan

of

Economics,

Quaid-I-Azam

Shamsher Mohamad INCEIF, Kuala Lumpur, Malaysia Aishath Muneeza School of Graduate INCEIF, Kuala Lumpur, Malaysia

and

Professional

Studies,

Murat Munkin College of Arts and Sciences, Department Economics, University of South Florida, Tampa, FL, USA

of

Andrea Paltrinieri Department of Economics and Business Administration, Università Cattolica del Sacro Cuore, Milan, Italy Mamun Rashid Department of Accounting and Finance, Universiti Brunei Darussalam, Gadong, Brunei Irum Saba Institute of Business Administration (IBA), Karachi, Pakistan Ali Sakti Bank Indonesia Institute, Jakarta, Indonesia Mehmet Saraç Istanbul University, Istanbul, Turkey Citra Atrina Sari National Committee for Islamic Economy and Finance (KNEKS), Jakarta, Indonesia Muhammet Yurtseven Süleyman Demirel University, Isparta, Turkey

List of Figures

Chapter 2 Fig. 1

Fig. 2

Mapping SDGs to the five primary maqasid linked with 39 corollaries of Chapra (2008) (Adapted from Obaidullah [2020a]) Proposed roadmap to align practices of Islamic finance to Maqasid Al-Shariah (Source Author’s own)

18 29

Chapter 3 Fig. 1

Way to achieve convergence of social responsibility and digitalization in Islamic economics and finance (Source Author’s own)

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Chapter 4 Fig. 1 Fig. 2

Fig. 3 Fig. 4

History of the formation of SDGs (Source Adapted from UN Department of Social and Economic Affairs, n.d.) Overview of SDGs and progress toward targets to be achieved by 2030 (Source Adapted from The Sustainable Development Goals Report 2019 [United Nations, The Sustainable Goals Report 2019, 2019a] and [United Nations, About the Sustainable Development Goals, 2020]) Links between SDGs and Maqasid e Shari’ah Linking the role of Islamic finance to SDGs (Source Adapted from Ahmed et al., 2015)

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60 68 73 xv

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LIST OF FIGURES

Chapter 7 Fig. 1

Fig. 2

Indifference curve of IBF stakeholders a. Initial set of preferences of Islamic finance stakeholders; b. Current set of preferences of Islamic finance stakeholders Optimal preferences

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Chapter 8 Fig. 1

Components of sustainable infrastructure (Source Author)

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Chapter 9 Fig. 1

Distinctive values of ESG concept from Shar¯ı’ah principles. Diagram A: The concepts of social and environmental finance within the business activities. Diagram B: The concepts of social and environmental finance which are separated from business activities

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Chapter 10 Fig. 1 Fig. 2 Fig. 3 Fig. 4 Fig. 5 Fig. 6 Fig. 7 Fig. 8 Fig. 9 Fig. 10 Fig. 11 Fig. 12

Environmental beliefs and behaviors Circular economy: conventional economy vs. Islamic economy Ecological footprint (Source Author’s own analysis) Domestic credit to private sector (Source Author’s own analysis) Domestic credit to private sector by banks (Source Author’s own analysis) Domestic credit to private sector by financial sector (Source Author’s own analysis) Ecological Footprint (income levels) (Source Author’s own analysis) Domestic credit to private sector (Source Author’s own analysis) Domestic credit to private sector by banks (income levels) (Source Author’s own analysis) Domestic credit to private sector by financial sector (income levels) (Source Author’s own analysis) Ecological footprint trends (Source Author’s own analysis) Domestic credit to private trend (Source Author’s own analysis)

232 235 243 243 244 244 245 245 246 247 247 248

LIST OF FIGURES

Fig. 13 Fig. 14

Domestic credit to private sector by banks trend (Source Author’s own analysis) Domestic credit to private sector by financial sector trend (Source Author’s own analysis)

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Chapter 11 Fig. 1

A proposed model of Islamic financial ecosystem as a catalyst for sustainable development

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Chapter 14 Fig. 1 Fig. 2 Fig. 3 Fig. 4

Fig. 5

Liquidity rate (%) (Source Prepared by authors. Data obtained from the data base of BRSA of Turkey) Capital adequacy ratio (%) (Source Prepared by authors. Data obtained from data base of BRSA of Turkey) Profitability rate (%) (Source Prepared by authors. Data obtained from data base of BRSA of Turkey) Ratio of NPLs to total credits (%) (Source Prepared by authors. Data obtained from the data base of BRSA of Turkey) Comparison of financial stability indexes (Source Prepared by authors)

335 336 336

337 338

Chapter 15 Fig. 1 Fig. 2 Fig. Fig. Fig. Fig. Fig. Fig. Fig.

3 4 5 6 7 8 9

Fig. 10

Private closed ecosystem model of APEX/Association Limited open ecosystem model of APEX/Association-Fintech Co. Public closed ecosystem model of APEX/Association Limited open ecosystem model of BMT-Fintech Co. Private closed ecosystem model of BMT The operation of BMT applying micro-fintech BMT pooling of fund before applying micro-fintech BMT mixed of fund after applying micro-fintech BMT mixed of fund after applying micro-fintech and Mudharabah Muqayyadah investment BMT allocation of fund after applying micro-fintech, Mudharabah Muqayyadah investment and Wadiah Amanah

363 363 364 365 365 367 369 371 374 375

List of Tables

Chapter 2 Table 1

Sustainability governance structure of Bank Muamalat Malaysia

27

Chapter 3 Table 1

Impact of Pandemic on Islamic economics and finance

38

Chapter 7 Table 1 Table 2 Table 3 Table 4

Breakdown of the global IFSI by sector and region (USD billion, 2018) Definition of variables used in the analysis Gini and financial credit: Panel data estimates Countries, banks, and first year of crediting

142 143 144 145

Chapter 9 Table Table Table Table

1 2 3 4

Shar¯ıah bases of value-based exclusions Environmental element of ESG and its Shar¯ı’ah values Social element of ESG and its Shar¯ı’ah basis Governance element of ESG and its Shar¯ı’ah basis

204 207 210 212

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LIST OF TABLES

Chapter 10 Table Table Table Table Table Table Table Table Table Table

1 2 3 4 5 6 7 8 9 10

Descriptive statistics Correlation matrix Results of pooled OLS Results of pooled OLS for OIC and Non-OIC countries Results of fixed effects for full sample Results of fixed effects for OIC and Non-OIC countries Results of random effects for high-income countries Results of random effects for OIC and Non-OIC Results of system GMM for all countries Results of system GMM for OIC and Non-OIC countries

241 242 249 251 252 253 254 255 256 257

Chapter 12 Table 1

Nationally driven transformations in some selected Muslim countries

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Chapter 13 Table Table Table Table

1 2 3 4

Table 5 Table 6 Table 7 Table 8

Variable description Descriptive statistics Correlation analysis Impact of Shari’ah-complaint finance on sustainable development Impact of Qard Hasan finance on sustainable development Moderating impact of Qard Hasan finance on sustainable development Robustness analysis Qard Hasan finance statistics

318 319 320 321 322 323 325 327

Chapter 14 Table Table Table Table

1 2 3 4

Financial stability index structure Definition of variables ADF (1979, 1981) and PP (1988) unit root test results Breitung and Candelon (2006) frequency domain casuality test results

334 338 340 341

Chapter 15 Table 1 Table 2

Characteristics of micro-fintech needed by BMT Micro-fintech needed by IMFI/BMT

356 360

LIST OF TABLES

Table Table Table Table Table

3 4 5 6 7

Table 8 Table 9

Rater agreement (Kendall W ) of respondents BMT balance sheet before applying micro-fintech BMT balance sheet-1 after applying micro-fintech BMT balance sheet-2 after applying micro-fintech BMT balance sheet-1 after applying micro-fintech and Mudharabah Muqayyadah BMT balance sheet-2 after applying micro-fintech and partial Mudharabah Muqayyadah BMT balance sheet 3 after applying micro-fintech and fully Mudharabah Muqayyadah

xxi 362 368 370 370 372 373 374

CHAPTER 1

Introduction M. Kabir Hassan, Mehmet Saraç, and Ashraf Khan

The Sustainable Development Goals (SDGs) are the call for engagement by all groups of countries toward the promotion of prosperity while ensuring the planet protection. They acknowledge that the objective of poverty eradication must accompany policies that lead to economic growth and deal with a variety of social requirements like health, education, social protection, and employment, while at the same time ensuring the change in climate and protection of the environment. Similarly, the disparaging series of events, such as global financial crisis and European debt crisis 2009/2010, have raised serious concerns about current financial practices and their impact on sustainability and stability of economy.

M. K. Hassan (B) University of New, Orleans, New Orleans, LA, USA e-mail: [email protected] M. Saraç ˙ Istanbul University, Istanbul, Turkey e-mail: [email protected] A. Khan Institute of Business Administration, Karachi, Pakistan e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8_1

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In this regard, Islamic finance has emerged as an alternative robust system to provide financial services based on mutual risk-sharing with strong ties with financial stability and serve the interest of average citizens around the globe. Islamic finance refers to the methods of raising capital by the Muslim countries’ corporations, including banks and other lending organizations, in accordance with Shariah/Islamic law. Governed by the ideology and ethics of Shariah, the comprehensive goal of Islamic finance is to bring about human well-being through enhancement in the welfare and prevention of impairment. In addition to avoidance of abusive practices and forbidden actions, the main characteristic of the Islamic financial system encompasses the “risk-sharing” and avoid interest-free contracts which do not involve vagueness or high risk. Based on the prominence of risk-sharing and asset-backed financing, Islamic finance can play a crucial part in supporting the accomplishment of Sustainable Development Goals. Most of the Muslim countries are facing the problem of high population and increasing pattern in poverty which restrict them to spend their limited funding on the sustainable goals set by the United Nations. It is believed that although financial sector possesses the capacity to discharge crucial functions toward the promotion of the SDGs, some limitations can be faced by the Muslim countries in mobilizing resources due to social and spiritual issues. Based on their spiritual beliefs, a number of Muslims disassociate themselves from the conventional financial sector because Islam prohibits interestbased dealings. In these circumstances, Islamic finance can be viewed as a substitute source for catering to the high demands of funds for infrastructure financing. In the countenance of considerable financing requirements for the Sustainable Development Goals, Islamic finance has shown itself as a potential and non-traditional foundation of funds for the said goals and has the potential to support inclusive growth, reduction of inequality, and acceleration in poverty eradication. Due to the increasing number of social, environmental, and healthrelated issues, there is a pressing need to publish a book with research focused status of SDGs and how it can help to accomplish these goals, especially in Muslim countries. The book primely redefines the role of Islamic finance, aligns SDGs with the objectives of the Islamic welfare state and presents models and instruments to overcome socio-economic problems.

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INTRODUCTION

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In Chapter 2, “Need to Redefine Islamic Finance in the Light of Maqasid Al-Shariah” M. Kabir Hassan, Aishath Muneeza and Mehmet Sarac emphasize to redefine Islamic finance in the light of objectives (maqasid) of Shariah and highlight the areas where Islamic finance needs to be redefined to serve the underpinning purpose of the Islamic welfare state. By considering the Islamic economic approach, they argue that Islamic finance should be designed through the macro socio-economic perspective, i.e., to eliminate all practices which are harmful to the society and environment and encourage the equal distribution of wealth to bring shared economic prosperity in the society. Therefore, such practices should be embedded in Islamic finance products and services to align them with a true spirit of Islamic finance. They find a gap in implementing maqasid-al Shariah in Islamic finance and propose that objectives (maqasid) of Shariah can be adopted by merging it with SGDs. In Chapter 3, “Pandemic Crisis, Digitalization and Social Responsibility: An Emerging Role of Islamic Economics and Finance” M. Kabir Hassan, Aishath Muneeza, and Ashraf Khan discuss the role of Islamic finance during pandemic crises. They argue that COVID-19 which started as health crises, however, has brough the economic systems into recession. The emphasis on reshaping the current economic and financial landscape including Islamic finance. They identify the impact of pandemic in three dimensions, i.e., from the perspective of the customers, institutions, and economies. Lastly, they suggest to redefine the role of Islamic finance in curbing the economic effects of COVID-19 by incorporating mutual social responsibility and digitalizing the products and services offered under Islamic finance. In Chapter 4, “Islamic Finance and SDGs: Connecting Dots” Irum Saba, Haneeah Jawed, and Ashraf Khan analyze the similarities between Islamic Finance and SDGs and present the way forward to achieve 17 SDGs in a fecund manner through Islamic finance. They anticipate that the implementation of SDGs requires a huge investment of $93 billion to build facilities of infrastructure, health, energy, and environmental projects. They considered Islamic finance as an alternative source of raising funds based on mutual risk-sharing along with halal avenues which will add value to the society at large. Lastly, the chapter presents models based on Islamic finance instruments to achieve the SDGs. In Chapter 5, “Islamic Finance: A Literature Review” M. Kabir Hassan, Ashraf Khan, and Andrea Paltrinieri comprehensively review the already published literature on Islamic finance. The chapter briefly

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describes the features of Islamic finance and identify the SDGs as an opportunity to expand its global share. Further, they discover that Islamic financial institutions have better governance structure, asset quality and naturally more resilient to absorb the shocks. They also present the dynamics of Islamic capital markets and takaful from previous literature. In Chapter 6, “The Role of Islamic Finance in Achieving Sustainable Development Goals (SDGs)” Mohamad Akram Laldin and Fares Djafri maintain the view that Islamic finance has a great potential in mobilizing resources for the sake of realizing the SDGs. The use of qualitative and inductive methods along with content analysis and find that through creative and productive modes of financing such as waqf, zakat, and sadaqah, Islamic finance can improve financial inclusion, financial sector stability, and eventually enhance the contributions of Islamic finance to the SDGs. Lastly, they also find convergence between underpinning objectives of Islamic finance and SDGs and highlight the importance of integrating SGDs with Islamic Finance for its effective implementation. In Chapter 7, “Islamic Finance and SDG 10: A Mirage” Hylmun Izhar and Murat Munkin assess the role of Islamic finance in achieving SDG goal 10 which is to reduce the inequalities in the world. They explore the development of Islamic finance and its social impact on the equal distribution of wealth. They argue that true spirit in the implementation of Islamic social and economic theory should have resulted in sustainable societal development. Nevertheless, the only development, that has been made, is the emergence of the Islamic banking and finance industry which is heavily criticized due to its convergence with mainstream finance and failed to realize Islamic economic system. They empirically find that Islamic banking initially supported to reduce income inequalities, however, due to financialization, it has failed to achieve SDG 10. In Chapter 8, “The Role of Islamic Financial System in Building Sustainable Infrastructure” Zahid ur Rehman Khokher identifies a massive gap of USD 2.6–3.4 trillion globally and USD 1–1.5 trillion annually for developing countries to fund sustainable infrastructure which is defined in the SDG goal 17. He argues that developing countries generally have limited fiscal space to fund infrastructure development and opt for alternative options which also add up in their debts. Thus, this chapter presents Islamic finance as a sustainable financial system and explore the role of its different instruments to generate funds to build infrastructure development in developing countries. Finally, an assessment is provided on the

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INTRODUCTION

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immediate impact of Covid-19 on the ongoing and future infrastructure projects and opportunities this crisis will bring for Islamic finance. In Chapter 9, “Sustainable Finance and a Shar¯ı’ Analysis of Environmental, Social and Governance (ESG) Criteria” Aminudin Ma’ruf, Ziyaad Mahomed, and Shamsher Mohamad attempt to understand and create awareness on the key commonalities and differences of ESG components within the framework of shariah and law. They point out that the major social and environmental issues, such as social inequality, poverty, corruption, loss of biodiversity, environmental degradation, and climate change, have brought the world at the crossroad. To overcome the aforementioned issues, they propose Islamic finance as an alternative system and review the already published literature on ESG and Islamic finance with the aim to design an Islamic ethical financial framework to serve the long-term sustainable prosperity. In Chapter 10, “Finance as a Source of Ecological Quality: Islamic Ethics of Environment and Empirical Evidence” Muhammad Tariq Majeed assesses empirically the nexus of financial development and ecological footprint in Organization of Islamic Cooperation (OIC) and non-OIC countries using a novel index of ecological quality and Islamic ethics of the environment. He finds the heterogeneous impact of financial development on the environment across OIC and non-OIC countries, i.e., financial development improves the environmental quality in OIC countries while the opposite is found in non-OIC countries. This chapter concludes that Islam sharia law encourages to achieve a high level of environmental quality and not to waste natural resources. In Chapter 11, “Islamic Finance and Sustainable Economy: A New Model of Islamic Financial Ecosystem” Sutan Emir Hidayat, Yodi Izharivan, and Citra Atrina Sari presents the model of Islamic financial ecosystem to support SDGs and consider it as a catalyst for sustainability in the economy. They argue that all Islamic financial sector and subsector suits to the SDGs, from Islamic social and commercial finance to the Islamic capital market. To efficiently promote and implement the SDG, the underlying basis of the Islamic financial ecosystem should incorporate and focused on regulations, human resources, research, digitalization, promotion, literacy, and communication. In Chapter 12, “Islamic Finance System as a Catalyst for Sustainability in the Economy” Muhammed Yurtseven, Kamola Bayram, and Tawfik Azrak point out income injustice and increase of poverty as major threats for SDGs and consider it as a political and social problem. They attempt

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to address three main puzzles (i) livable life expectancy through the lens of the Islamic economic system (ii) What steps are required to eliminate income inequalities under the Islamic economic system (iii) How Islamic economic system can help to achieve sustainable development? The results reveal the social vision of the Islamic economy by addressing all aspects of income injustice and sustainable survival strategies. In Chapter 13, “Qard Hasan (Interest-Free Loan) as a Tool for Sustainable Development—Global Evidence” Rashedul Hasan, M. Kabir Hassan, and Mamun Rashid assess the importance of Qard Hasan which is an interest-free loan and consider it as a tool to achieve SDGs. Using a comprehensive dataset collected from the World Bank and Islamic Financial Service Board (IFSB), they empirically find that Qard Hasan can play an instrumental role in the implementation of SDGs. Further, they propose that the addition of Qard Hasan in the portfolio of Islamic finance products can accelerate the growth of SDGs. In Chapter 14, “Contribution of Islamic Banks on Financial and Economic Stability: An Empirical Comparison Between Conventional and Islamic Banks” Selim Kayhan and Tayfur Bayat argue that the banking system plays a central role in the implementation of economic policies, especially after the modification in monetary policies and banking regulation caused by global financial crisis in 2008. Thus, they aim to assess the performance of the banking system in achieving financial stability and consequently its effect on macroeconomic indicators in Turkey. The results show that Islamic banks are less profitable, and their customers are not loyal to their loans. However, after building the stability index, they establish that the financial stability of Islamic banks follows an upward trend and stable path as compared to its counterpart. Overall, they conclude that Islamic banks are more effective in achieving financial and economic stability which is due to the fact that Islamic banks directly finance the real side of the economy. In Chapter 15, “Proposing New Islamic Microfinance Model for Sustainable Islamic Microfinance Institution” Ascarya and Ali Sakti argue that the emergence of fintech has equally impacted the Islamic finance industry and propose the new model of Islamic microfinance model based on fintech. They investigate the features of fintech and its suitability for Islamic microfinance and build a model based on Islamic social and commercial finance along with the implementation of fintech which would ensure the sustainability of microfinance institutions in Indonesia. They find that the proposed model of micro-fintech should adopt Wadiah

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INTRODUCTION

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Amanah, Mudharabah Muqayyadah, waqf long-term investment deposits or waqf equity, P2P financing intensively as the source of commercial funding; and P2P social intensively to raise zakat-infaq-sadaqa-waqf (ZISWaf).

PART I

Islamic Finance and Sustainable Development Goals: Two Sides of the Same Coin

CHAPTER 2

Need to Redefine Islamic Finance in the Light of Maqasid Al-Shariah M. Kabir Hassan, Aishath Muneeza, and Mehmet Saraç

1

Introduction

The history of Islamic finance began with the inception of Islam in the world. However, the modern institutionalization of Islamic finance began in the 1960s with the establishment of the first Islamic bank, Mit Ghamr in Egypt in 1963. Prior to this, Islamic finance was practices in isolation at an informal level in communities where Muslims wanted to practice Muamalat or commercial matters in accordance with Islamic law. These ad hoc practices were customized as per the requirement of the societies

M. K. Hassan (B) Department of Economics and Finance, University of New Orleans, New Orleans, LA, USA e-mail: [email protected] A. Muneeza School of Graduate and Professional Studies, INCEIF, Kuala Lumpur, Malaysia e-mail: [email protected] M. Saraç ˙ Istanbul University, Istanbul, Turkey © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8_2

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and the benefits from these practices were enjoyed by Muslims of selected communities. When institutionalization of Islamic began, the compatibility of it with the conventional financial system was questioned and it was considered as a remote event that will not be sustainable in the world. Though the first attempt of institutionalization of Islamic finance was not so successful as due to political turmoil it has to close down after a few years, the fruits of the effort only reaped when other parts of the world began the replication of it. Today, the successful attempt made in 1963 is evident as the whole world has not only accepted Islamic banking as a system, but a full-fledge Islamic finance system has been established due to that single event. The global Islamic financial industry has developed over the last twenty years and there are 50 Muslim and non-Muslim countries in the world where Shariah compliant financial products and services are offered (BNM, 2018, p. 8). The list of challenges faced by Islamic finance since 1963 up until now is endless. It has faced criticisms since day one until now. One of the most critical challenge which often is undermined is the issues Islamic finance has to face when Shariah rules applicable to it is being practiced in jurisdictions where domestic laws does not acknowledge Shariah rules to be applied for commercial matters as there is a full-fledge commercial legal framework applicable to commercial matters including Islamic finance which was enacted even before the contemplation of adoption of Islamic finance in the world. As such, this incompatibility of laws created conflicts that changed the way how Islamic finance products in different countries work in practice. Often it is asked: when the same Shariah contracts are applied all over the world in Islamic finance; why is the practice of it is not uniform? In some jurisdictions, an Islamic finance contract might have an easy process while in some other countries, the same contract might have a complex process to the extent the critics without realizing the legal challenges the implementation process of the simple Shariah contract faced might simply say that Islamic finance is just a mere change of name or it is just one and the same. The reality is often these critics only view and review Islamic finance while in an armchair. They have neither tried nor experienced the extent one had to and still has to go to implement Islamic finance in countries that has a legal system which does not consider Shariah as part of it. The simple modus operandi of Shariah contracts becomes complicated is one effect of having a conventional legal system in place. Not only this, the legal system in place also dictates what Shariah contracts could

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be practiced in the jurisdiction. This means that the legal system of the country plays a vital role in determining the feasibility of the contracts that could be practiced in a particular jurisdiction considering practical factors like whether the taxes imposed on the transaction will make Islamic finance contracts more expensive than the conventional finance contracts. Harmonization of law and Shariah is a process often which is not spoken about in relation to Islamic finance; but it is strongly believed that this is the right time to deliberate on this and review Islamic finance from this perspective in the hope that Islamic finance practices will be aligned with Shariah and it will achieve the objectives of Shariah or Maqasid Al-Shariah which calls for elimination of all harm by offering benefit and ease to the society. The call for aligning Islamic finance practices with Maqasid Al-Shariah is important to ensure that Islamic finance practices truly reflects essence of the lex loci applicable to it. As such, redefining Islamic finance in the light of Maqasid Al-Shariah is imperative and has become relevant today as this is the era of ethical, sustainable and responsible financing that advocates for value addition the financing brings to the society and environment rather than the egoistic or individualistic benefits it gives to an individual or a corporation. Furthermore, the United Nation’s Sustainable Development Goals (SDGs) has created a quest among the countries in the world to achieve these 17 goals before 2030 and obtaining the required financing for it vests with the governments, financial institutions and high net worth individuals/corporations. In this regard, Islamic finance is considered as an alternate source of financing that has its commercial finance segment and social finance segment to financially assist the countries. This chapter is divided into five sections. Followed by this introduction, Sect. 2 discussed Maqasid Al-Shariah in a nutshell while Sect. 3 discusses the need to redefine Islamic finance in the light of Maqasid Al-Shariah. Section 4 deals with the roadmap to align practices of Islamic finance to Maqasid Al-Shariah with recommendations followed by conclusion.

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2

Maqasid Al-Shariah in a Nutshell

Maqasid Al-Shariah is the objectives of Shariah that need to be achieved by anyone who adhered to the religion Islam. The main objective of Shariah is to ensure that all evil is prohibited; but all good is promoted so that no one will be harmed. There is an effective cause behind each and every action that is lawful and unlawful in Shariah. Asking why an action is lawful or prohibited is equivalent to ask what is the maqasid of it and levels of why represents the levels of maqasid (Auda, 2008). There are four dimensions of Maqasid: levels of necessity, which is the traditional classification; scope of the rulings aiming to achieve purposes; scope of people included in purposes; and level of universality of the purposes (Auda, 2008, p. 7). Auda (2008) states that the traditional classification of maqasid is divided into three levels of necessities that are: necessities (Darurat), needs (Hajiyyat), and luxuries (Tahsiniyyat) and Darurat is further divided into preserves one’s faith, soul, wealth, mind, and offspring. The things considered as Hajiyyat are less essential for human life such as marriage, trade, and means of transportation and things considered under Tahsiniyyat includes anything used for beautifying purpose such as using perfume, stylish clothing, and beautiful homes (Auda, 2008, p. 7). Al-Ghazali (1998) states that Maslahah is the protection of five essentials or Darurat and everything that protects these five essentials of life is considered as Maslahah while everything that distorts the protection of these five essentials lead to Mafsadah or evil. Therefore, removing Mafsadah leads to Maslahah (Al-Ghazali, 1998). Al-Shatibi considered the levels in hierarchy interrelated and overlapping (Auda, 2008). Auda (2008) states that between fifth and eighth centuries, the jurists that made the most significant contribution to Maqasid is Abu al-Maali al-Juwaini, Abu Hamid al-Ghazali, al-Izz Ibn Abdul-Salam, Shihabuddin al-Qarafi, Shamsuddin Ibn al-Qayyim, and most significantly, Abu Ishaq Al-Shatibi. Among these scholars the most significant two scholars who contributed to the development of maqasid are Al-Shatibi and Al-Ghazali (Jalil, 2006). It is said that Imam al-Juwaini is the first to formulate the hierarchy of needs or level of necessities as it is seen today and he suggested five levels of maqasid: necessities (Darurat), public needs (al-hajah al‘amah), moral behavior (al-makrumat), recommendations (al-mandubat) and “what cannot be attributed to a specific reason” proposing that the purpose of the Islamic law is the protection or inviolability (al-‘ismah)

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for people’s “faith, souls, minds, private parts, and money” (Auda, 2008, p. 21). Al-Ghazali who was a student of Imam al-Juwaini, ordered the necessities which al-Juwaini in the following order: faith, soul, mind, offspring, and wealth and he coined the term “al-hifz” or preservation of these necessities (Auda, 2008, p. 21). Maqasid Al-Shariah is a timeless concept and it ought to be applied in all times to all aspects of human lives including Muamalat or commercial matters. As such, today more than ever, the debate to link Maqasid Al-Shariah with Islamic finance has emerged to ensure that the higher objectives of Shariah embedded in Islamic finance; rather than merely on focusing of inventing and innovating products that is not tainted with riba, maysir (gambling) and gharar (excessive ambiguity) or adheres to the Shariah rules of Islamic commercial contracts that is used to structure them.

3 Need to Redefine Islamic Finance in the Light of Maqasid Al-Shariah In the light of Maqasid Al-Shariah, there is a need to redefine Islamic finance in the hope of creating greater good and avoidance of harm to the society and the environment. It is said that there are five key principles that represents responsible finance: fairness focusing on fair treatment to all key stakeholders; transparency by providing clarity and disclosure of all information in an informed manner that will assist the stakeholders to make their decisions in an informed manner; the greater good which simply means that financing activities ought to go beyond the classical notion of profitability where the greater good for the whole society is considered; treatment of cleansing the income derived from impermissible activities shall be practiced for both kinds of finance; and social dimension ought to be considered in financing activities (RFI Foundation & Islamic Financial Services Board, 2019, p. 4). Linking Maqasid Al-Shariah to Islamic finance will show that Shariah compliance of Islamic finance transactions and contracts is not the only concern that the Shariah governance mechanism put in place by Islamic financial institutions that need to be dealt with. It goes beyond mere shariah compliance transactions and contracts of Islamic finance as promoting greater benefit to the society should be the ultimate target and this could be adopted via procedures put in place to achieve the principles of Maqasid Al-Shariah. This issue is simplified by Rosly (2015) who states

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that shariah compliance of a financial contract need not only be judged from contract perspective; but it ought to be evaluated from the impact it created from an economic and social perspective where the benefits and harm it creates to the society are taken into consideration. In this regard, he uses an example to illustrate the point where he states that there is no point of calling Islamic finance as an alternative to conventional financing if it puts customers into debt leading to bankruptcy and he believes that Islamic financial products ough to promote economic development by refining the living of people and eradicating poverty (Rosly, 2015). The need to redefine Islamic finance in the light of Maqasid Al-Shariah arise not because there is a non-Shariah compliance issues found in it. But this call is to ensure that Islamic finance brings value addition to the society and it is impactful in resolving the issued faced by all in the society without neglecting the need of any. The existing Shariah mechanism put in place by Islamic financial institutions only ensure whether the transactions and contracts are concluded as per Shariah; but how much those products have achieved Maqasid Al-Shariah is not assessed or the impact of Islamic finance in this regard is not measured making the application and interpretation of Shariah in this regard much narrower than it actually is. The common good to the society including the environment is ignored at the expense of protecting the benefit of the stakeholders of the Islamic financial institution. Al-Mubarak and Osmani (2010) conducted a research to find out the current Islamic banking practices in the light of Maqasid Al-Shariah where it was concluded that Bai’ Bithaman Ajil (BBA) contracts used in Islamic banking created mafsadah than maslahah as using this contract Islamic banks imitate the conventional banking where using fractional reserve system, Islamic banks also create money out of money from “thin air violating the principles of equal distribution, societal welfare, justice, on the way to create a higher default rate, debt loans and similar other greater mafasid” (Al-Mubarak & Osmani, 2010, p. 10); the rahn or pawn broking against guard “violates the fundamental maqasid (objectives) of hifz al-deen primarily, and secondarily the maqasid of establishing Islamic Banks, i.e., dealing with interest free monetary policies for the Muslims, providing economic welfare, social equality, and a free flow of money among the citizens” (Al-Mubarak & Osmani, 2010, p. 10); and bai’ ‘inah and tawarruq contracts also contravenes Maqasid Al-Shariah and as such it “should be thought over once again before sanctioning it for the society” (Al-Mubarak & Osmani, 2010, p. 13). They also introduced

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two terms called: macro maqasid which means fulfilling the Maqasid AlShariah at a macro level by providing a flow of economic activities in the overall economic system and micro maqasid which means fulfilling the Maqasid Al-Shariah at micro level where individuals/corporations benefit and the believed that though at macro maqasid level all those Islamic banking contracts could have achieved Maqasid Al-Shariah, at micro maqasid level it has failed (Al-Mubarak & Osmani, 2010, p. 14). They also expressly stated that having a Shariah compliant structure with funding from Islamic financial institutions does not make it a transaction that has achieved Maqasid Al-Shariah; it is proper due consideration and care given to the environment, stakeholders with socio-economic consideration that will align it to Maqasid Al-Shariah and Islamic bank ought to consider “investments in biodiversity projects, natural power plants, and environmental friendly Investments” (Al-Mubarak & Osmani, 2010, p. 15). Following discussed are the approaches that can be taken to redefine Islamic finance to align with Maqasid Al-Shariah. 3.1

Merging Islamic Finance with SDGs

As Khan (2019a) argues that Islamic finance need to be reformed to achieve SDGs and he believes that like Maqasid Al-Shariah SDGs also calls for preservation of human development. When it comes to the protection of society and environment, in the contemporary times United Nation’s 17 SDGs are used. By referring to Chapra (2008), who has compiled a list of 39 corollaries to the five maqasid, Obaidullah (2020a) has enhanced the list by mapping SDGs to the five primary maqasid as well as their respective corollaries. This is shown in Fig. 1. Obaidullah (2020a) observes that the United Nations’s UNSDG goals are formulated to be achieved in different societies with different cultures and religions and as such there could be misalignments when it is compared with Maqasid Al-Shariah where it is evident from Fig. 1 that out of the 39 corollaries of Chapra (2008), 10 cannot be mapped to any of the SDGs as these 10 corollaries represents religious dimension whereas SDGs does not represent any religion or spiritual dimension (Obaidullah, 2020a) though this does not mean that the moral aspect is not found in it (Obaidullah, 2020b). This analysis made by Obaidullah (2020a) shows that Maqasid Al-Shariah is much more comprehensive than SDGs which cover only worldly dimensions; whereas Maqasid Al-Shariah covers spiritual aspect as well balancing success (falah) in this world and hereafter

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Protection of life

Protection of religion

Protection of intellect

Protection of progeny

Protection of wealth

dignity, self-respect, brotherhood & social equality-SDGs 16 & 5

Religious worldview- No SDG

Emphasis on the maqasid in the intepretation of textsNo SDG

Moral development-No SDG

Education, research and improvement in technology & management-SDG 4

justice-SDG 16

Values- No SDG

Need of high quality religious & science education-SDG 4

Proper upbringing & family integrity- SDG 5

Security of life, property & honor- SDG 16

Spiritual & moral uplift-no SDG

Proper motivation- No SDG

Other requisites: library & research facilities-SDG 9

Need fulfilment- SDGs 1 & 2

Good governance- SDG 16

Security of life, property & honor-SDGs 16 & 5

Religious & moral education- No SDG

Freedom of thought & expression-SDG 16

Clean & healthy environment-SDGs 3 & 6

Freedom of enterprise-SDG 8

Freedom- SDG 16

Enabling environment for righteousness, family, social solidarity- No SDG

Reward for creative workSDG 9

Freedom fear, conflict, insecurity & debt-servicing burden- SDGs 16 & 5

Employment & selfemployment opportunitiesSDG 8

Education-SDG 4

Role of the state in creating enabling environment-No SDG

Finance- SDG 17

Removal of poverty, need fulfilment & equitable distribution- SDGs 1, 2, 10

Good governance- SDG 16

Social solidarity & mutual trust- SDG 17

Removal of poverty & need fulfilment-SDGs 1 & 2

Saving & investment- SDG 17

Employment and selfemployment opporunitiesSDG 8 Equitable distribution of income & wealth-SDG10 Marriage & Stable family life- SDG 5 Family & social solidaritySDG 5 Minimization of crime & anomie- SDG 16 Mental peace & happinessNo SDG

Fig. 1 Mapping SDGs to the five primary maqasid linked with 39 corollaries of Chapra (2008) (Adapted from Obaidullah [2020a])

that is derived from the philosophies of Islamic worldview. According to Chapra (2008) and Obaidullah (2020a), the word falah has been stated in the Quran for 40 times while fawz another word used to indicate the same is used in the Quran for 29 times with its derivatives. It is imperative to note that Islamic finance should not have any issue in achieving SDGs as already Maqasid Al-Shariah is an approach that should be adopted and considered in it. However, this is one aspect of Islamic finance where the theory and practice need to be aligned. Therefore, the current focus of Islamic finance should be on aligning the Islamic finance practice to Maqasid Al-Shariah rather than aligning it with SDGs. The effect of aligning the practice of Islamic finance to Maqasid Al-Shariah will automatically achieve the SDGs and this is clearly understood from Fig. 1.

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Merging Islamic Finance with Circular Economy

The circular economy model which was proposed in 1980s emphasizes on efficient use of resources with economic development where products are viewed as services instead of owned goods like for instance, when a person buys a washing machine, he is buying the washing service instead of the actual product. In short, circular economy calls for sustainability of resources. Circular economy model advocates for moving away from the linear economy that promotes sustainable economy by promoting sustainability and reducing waste (Hassan et al., 2020). Linking Islamic finance with circular economy is easy as the notion of circular economy is in line with Maqasid Al-Shariah where resource sustainability and conservation of resources is part of it. Khan (2019b) states that there are two competing paradigms of human motivation and behavior which is evident from the Quranic verse, 42:20. The first paradigm is that the driving factor behind human behavior is sheer material considerations where wasteful instincts drive the attitudes of entrepreneurs, individuals, households, and firms which according to the Quranic verse, 17:27 is considered as an act of devil Khan (2019b, p. 192). The second paradigm is that human conscience is driven by balancing between worldly (which for profit motivations of this life) and hereafter (which not for profit motivations of this life) matters as indicated in the Quranic verse, 2:201 Khan (2019b, p. 192). Khan (2019b) states that the modern linear economy falls within the first paradigm as it causes social inequalities and environment balances while entrepreneurship falls within the second paradigm as from an Islamic perspective entrepreneurship must be done honestly, trustworthy manner with compassion and a balance that also include environmental concerns (Khan, 2019b). Khan (2019b, p. 192) states that Islamic economics and finance has been influenced by the first paradigm as via legal stratagems the instruments that was supposed to be used with compassion like Kafalah, daman, tawarruq, wad, and hawalat al-dayn turned into commercial activities where the value addition it bring to the society is forgone at the expense of the financial return. Therefore, linking Islamic finance to circular economy is required to recalibrate Islamic finance toward Maqasid Al-Shariah.

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3.3

Merging Islamic Finance with Impact Investing

Impact investments are “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return” (Global Impact Investing Network, N/A). IICPSD and UNDP (2014, p. 9) states that the definition of JP Morgan Chase made on impact investment is wider than that of Global Impact Investing Network where they view that: “Impact investments are investments intended to create positive impact beyond financial return. As such, they require the management of social and environmental performance in addition to financial risk and return.” There are different characteristics that adhered in impact investing. For instance, Global Impact Investing Network states that in impact investing there ought to be features like intention to produce social and environment impact; return for an expectation which is the return on capital is the minimum expectation; and impact need to be measured (IICPSD & UNDP, 2014, p. 9). Attempts have been made to link Islamic finance with sustainable, responsible and impact (SRI) investing and the global assets of SRI investing have exceeded USD 30 trillion while the global assets of Islamic finance have reached USD 2 trillion (CFA Institute, 2019, p. 2). Islamic finance has also been considered as mode of financing that has considered environmental, social, and governance (ESG) issues in it (CFA Institute, 2019). The examples of environmental issues considered in this regard are water pollution, air pollution, biodiversity, climate change, and deforestation; social issues are related to data protection, diversity, employee relations, government relations, and community relations; and governance issues are related to board composition, accounting standards, anticompetitive behavior, bribery and competition and compliance (CFA Institute, 2019). In SRI investing, there are six main methods used in considering ESG issues which are exclusionary screening that refers to the method using traditional or classical moral values as securities are selected that are within the ambit of these moral values to be qualified; best-in-class selection which is also known as positive selection, positive screening, or positive alignment where companies with improved or better ESG performance comparative to sector peers that is implemented on either the level of or the change in ESG performance is considered; active ownership that refers to the practice of entering into a dialogue with companies on ESG issues and exercising both ownership rights and voice to effect change;

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thematic investing that refers to investing that is based on trends, such as social, industrial, and demographic trends; impact investing that refers to investing with the disclosed intention to generate and measure social and environmental benefits alongside a financial return; and ESG integration refers to systematic and explicit inclusion of ESG risks and opportunities in investment analysis (CFA Institute, 2019, pp. 7–8). Islamic finance is closely linked to impact investing as prescribed from the objective of Shariah, Islamic finance avoid all kind of harm while promoting all kind of benefit. It is observed that the ESG method most frequently used in Islamic finance is exclusionary screening where shariah compliance is adhered in all sectors of Islamic screening by avoiding all prohibitions such as riba (interest), excessive gharar (uncertainty), maysir (gambling), khamr (alcohol) (CFA Institute, 2019). CFA Institute (2019) observes that tobacco represents an interesting case of Islamic exclusionary screening where though it is not a prohibited activity derived from the explicit source of Shariah, since it is harmful to humans it is prohibited by contemporary scholars indicates that Islamic exclusionary screening may continue to evolve with respect to ESG issues. This example of tobacco shows that after the mandatory requirements of prohibited activities are complied with the Islamic financial institutions, it is also going toward extending these prohibitions based on ESG perspective which also aligns with the Maqasid Al-Shariah approach advocated. It is also observed that it is not only in Islam, convergence of ESG is promoted in finance as for example, Judaism and Christianity also interest is prohibited (CFA Institute, 2019). 3.4

Merging Islamic Finance with Ethics

Ethical finance is also known as responsible investment. Responsible investment is defined as “an approach to investing that incorporates ESG factors into investment decisions to better manage risk and generate sustainable, long-term returns” (PRI, 2017). It is also viewed that between responsible investment and Islamic finance, there is a close relationship as both advocates for social good linking its activities to real economy striving to eliminate unsustainable system risk while promoting the idea to have a more resilient financial system (PRI, 2017). However, there are also differences between the two as from a general investment approach, responsible investment uses an approach where any ESG information that could be substantial to investment performance is

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added while in Islamic finance, moral values-based exclusionary screening approach are used; from active ownership perspective, in responsible investment there is a robust importance on becoming active owners and to deal with companies on ESG issues including proxy voting while in Islamic finance, there is no such practice; in responsible investment, there it is not widely accepted to give consideration to avoid investments in highly leveraged companies, but in Islamic finance, this is considered as avoiding in companies with excessive leverage is made as a priority; and in responsible investment the impact of investment is not widely considered though now with emergence of ESG, the trend is being set, but in Islamic finance, the Shariah scholars consider shariah compliance of financial products though actual impact or impact on real economy is not considered (PRI, 2017). Lack of ethical values inter alia creates instability in the financial system and creating synergy between ethical finance and Islamic finance can benefit the international financial system (RFI Foundation & Islamic Financial Services Board, 2019). Islamic finance itself has embedded with ethical and religious principles supporting economic and social prosperity where halal finance has attracted outstanding eagerness via a “cyclical interest in sustainable development” (Ougoujil & Rigar, 2018, p. 971). The change in geo-financial paradigm that has led to merge ethics with finance started when the opportunity to realize the resilience ethical financial institutions including Islamic financial institutions in times of financial crisis was created to understand that Socially Responsible Investment (SRI) and Islamic finance belongs to the group of ethical finance (Ougoujil & Rigar, 2018). There are two main characteristics common between SRI and Islamic finance: “they use extra-financial parameters and are considered by the main financial centers of the world as very attractive development axes” (Ougoujil & Rigar, 2018, p. 958). It is also viewed that there is an “ethical bridge” between Islamic finance and SRI investing where some of the practical examples of these have been evident such as in the Unites States, one of the largest equity funds, Amana Mutual Funds it has been said that they look for companies with sustainable characteristics which are not only profitable and financially strong, but also that follows stringent ESG policies; a larger asset management company in Saudi Arabia, SEDCO Capital uses classical Islamic screening with modern ESG considerations as a prudential ethical approach paving way to financial outperformance; green sukuk which was first issued in Malaysia in 2017, used ESG criteria in sukuk that was issued

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under Malaysia’s SRI Sukuk Framework issued by Securities Commission Malaysia that was followed by subsequent issues of it and as part of its fundraising for a water, sanitation, and hygiene program to fight cholera and other such diseases the International Federation of Red Cross and Red Crescent Societies (IFRC) is reportedly working with the Islamic Development Bank (IsDB) to issue a sukuk (CFA Institute, 2019, p. 11). It was reported in May 2019 that a multi-million dollar fund to combat cholera and other diarrheal diseases in OIC countries will be launched by IsDB with IFRC (IsDB, 2019). It is also reported that half of the OIC signatories have joined Principles for Responsible Investment (PRI) (PRI, 2017), which is considered as a global proponent for responsible investment which works toward understanding the implications of ESG (PRI, N/A). A study has been carried out by Khan and Mohomed (2017) to understand the differences between Islami Bank Bangladesh Limited, an Islamic bank and Triodos Bank (which is headquartered in Netherlands), an ethical bank where it was found that there are some similarities and differences between the two types of banks. The similarities highlighted between the two include, both banks practices environment friendly banking and SME financing adopting risk management as well as corporate governance and enhanced transparency corporate social responsibility, working culture with integrated reporting (financial and risk reporting plus ESG disclosures) and there are voluntary internal regulations adopted by both banks; for Islami Bank Bangladesh Limited it is Shariah board while for Triodos Bank it is supervisory board (Khan & Mohomed, 2017, p. 142). Some of the differences between the two highlighted include, Islami Bank Bangladesh Limited practices Islamic banking while Triodos Bank practices conventional banking based on interest and Islami Bank Bangladesh Limited practices need-based, socially responsive and development focused banking which is welfare-oriented heavily practicing financial inclusion while Triodos Bank practices sustainable banking (Khan & Mohomed, 2017, p. 143). Abu Hurayra (2015) conducted a study to find out how much the practices of Islami Bank Bangladesh Limited has aligned with Maqasid Al-Shariah where it is concluded that though the bank has successfully achieved macro Maqasid Al-Shariah, micro Maqadis Al-Shariah is yet to be achieved. There are many Islamic banks in the world that has been striving to align its practices toward ethical banking practices. In this regard, the CIMB Group of Malaysia, which includes CIMB Islamic, is a founding

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member of the United Nations Environment Programme Finance Initiative Principles for Responsible Banking (CIMB, N/A) while the Jordan Islamic Bank publishes social sustainability report from 2012 on annual basis and it has formed a social responsibility committee at Board of Director’s level and at executive management level wherein the memorandum and articles of association of the company it is stated that one of its objectives is to meet the economic and social needs via banking (Jordan Islamic Bank, 2016, pp. 28–29). Not only this but the Jordan Islamic Bank has set up a social responsibility unit and it has formulated a strategic sustainability plan where the objectives include target in next five years for the bank to use 50% renewable energy for its consumption; safeguard the environment and minimize the negative impact on the environment; promote sustainability and social responsibility culture among related parties and focus more on financial inclusion (Jordan Islamic Bank, 2016, p. 30). The most notable initiative of Jordan Islamic Bank is the initiative it has taken to provide qard al-hasan or interest-free loan to those who are in need of it to fulfill its social role owing to the society (Jordan Islamic Bank, 2016, p. 34) and this is something which can be learnt by other Islamic banks in the world too as fulfilling the need of all segments of populations shall be given consideration to. It was reported that these qard al-hasan was given to the needy to fulfill their medical, education and marriage needs and since the incept of the bank until the end of 2019, the total value of these interest-free loans have reached to 302.6 million Dinars (Jordan Islamic Bank, 2019, p. 14). Furthremore a mutual insurance fund has been initiated by the Jordan Islamic Bank in 1994 with the objective among others to save debtors who is in a difficult situation to pay off their debts (Jordan Islamic Bank, 2016, p. 35). The number of subscribers to this mutual fund at the end of 2019 is 158.6 thousand subscribers; the total funds in it has reached to 1.3 billion dinars; and the amount of compensation disbursed has increased to 13.0 million Dinar (Jordan Islamic Bank, 2019, p. 15). There is no doubt that ethical values are embedded in Shariah (Kamali, 2008) and as such, Islamic finance ought to embrace it in all its products and services offered. However, positive action is required from all stakeholders of Islamic finance to align Islamic finance products and services to ethics in a way that creates more value addition to the societies in which it operates. There are many Islamic banks as discussed, who are striving to do that, but what is required is collective effort to include this as a

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immutable feature in Islamic finance that would be there irrespective of the jurisdiction in which it is adopted. 3.5

Merging Islamic Finance with Value-Based Intermediation (VBI)

Value-based intermediation (VBI) for Islamic finance was introduced by the central bank of Malaysia, Bank Negara Malaysia to strengthen the roles and impact of Islamic finance (BNM, 2018). The VBI strategy paper was introduced by Bank Negara Malaysia in collaboration with founding members of VBI Community of Practitioners comprising Bank Muamalat Malaysia Berhad, Agrobank, CIMB Islamic Bank Berhad, Bank Islam Malaysia Berhad, and HSBC Amanah Malaysia Berhad and focuses on implementation of appropriate ways in producing positive and sustainable result to the community, economy, and environment in a manner where sustainable returns and long-term interests of the shareholders will not be compromised (BNM, 2018, p. 1). The approach Malaysia has implemented to adopt VBI strategies is that first it is applicable to Islamic banking only though the strategies could be universally applied for the whole Islamic finance sector; the VBI strategies will be practically applied by the Islamic banks using a business-driven approach where the respective Islamic banks adopt them as per the level of their maturity; and the consultative approach paves way for effective collaboration between the stakeholder with mutual understanding (BNM, 2018). VBI benefits financial industry by providing greater innovation, enhanced efficiency and effective ecosystem; customer and community by improving the standard of living with fair and transparent treatment; government by realigning of business focus with national agenda; and regulator by strengthening financial stability (BNM, 2018, p. 6). The underpinning thrusts of VBI are based on entrepreneurial mindset, community empowerment, good self-governance, and best conduct (BNM, 2018). VBI implementation is implemented by Islamic banks using the level of maturity in collaboration with stakeholders who will “promote a conducive environment via various strategies that aim to expedite implementation of this initiative via strategic networking, nurturing potential champions, enhanced disclosure and performance measurement” (BNM, 2018, p. 6). There are six strategies in the VBI strategy developed by BNM to the Malaysian Islamic finance industry.

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It is also expressly stated that VBI is not a new concept as it shares similarities between established contracts like Environmental, Social and Corporate Governance (ESG), Ethical Finance and Sustainable, Responsible, Impact Investing (SRI), but the main difference between these concepts and VBI is that VBI used Shariah to determine its underlying values (BNM, 2018, p. 14). VBI and Corporate Social Responsibility (CSR) is different as well where VBI focuses on doing good that is well integrated within business activities such as offerings and practices (as a source of competitive advantage) while CSR initiatives are usually separated from business activities (on philanthropy basis) and it is perceived as a cost center, not a profit center (BNM, 2018, p. 14). There are positive implication for Islamic banks who adopts VBI in Malaysia. For example, Bank Muamalat Malaysia has included a sustainability statement in their annual reports where they explain the VBI impacts are summarized. For instance, in the annual report of 2019 of Bank Muamalat Malaysia states that stakeholder’s value is created via adoption of five shared values that include respect, care, serviceoriented, innovative, and integrity (Bank Mumalat Malaysia, 2019, p. 72). Bank Muamalat Malaysia in this regard has identified six stakeholders: local community, customers, suppliers, investors, regulatory agencies, employees, and statutory bodies (Bank Muamalat Malaysia, 2019, p. 72) and they have disclosed a sustainability governance structure where the head of each department is given responsibility in this regard as shown in Table 1. Energy consumption and environment impact, financial inclusion, responsible financing is some of the key areas focused in the said annual report. Wakaf Muamalat is an exclusive initiative taken by Bank Muamalat which has been implemented since 2012 in affiliation with State Islamic Religious Councils and until the end of 2019, the amount collected for this cash waqf fund is RM26,737,824.47 (Bank Muamalat Malaysia, 2019, p. 101). To become a socially responsible bank, Bank Muamalat Malaysia has also have established “Tabung Mawaddah” with the objective of donating money to those in need in the society which is funded by zakat and sadaqat received (Bank Muamalat Malaysia, 2019, p. 103).

Execute all value-based operations and activities

Responsibility Execute all value-based operations and activities

Head of Human Capital Division Deliberates, oversees, and acts as custodian to all value-based initiatives

Head of Corporate Planning Department

Adapted from Bank Muamalat Malaysia (2019, p. 73)

Head of Business Unit

Head of Customer Service Department Engagement with customers to ensure value-based initiatives materialize

Head of Shariah Department

Reviews value-based initiatives from Shariah perspectives

Sustainability governance structure of Bank Muamalat Malaysia

Head of Department

Table 1

Head of Dakwah, Wakaf and Zakat Department Strategize and materialize value of Tabung Mawaddah and wakaf fund to ensure the usage of the fund is diversified

Head of Corporation Communication Department Internal and external communication on value-based and its importance

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4 Roadmap to Align Practices of Islamic Finance to Maqasid Al-Shariah The road map to align practices of Islamic finance to Maqasid Al-Shariah is important to be enacted. Without proper vision and will to bring a change, automatically nothing will happen. As such, this is the right time to formulate a roadmap to align the practices of Islamic finance to Maqasid Al-Shariah. To start with, it is also important to consider that there are two types of Islamic finance: that is Islamic commercial finance and Islamic social finance depending on the objectives it. This distinction is important to understand the practical differences between the two types in the implementation stage and there are some specific and special institutions and tools used in Islamic social finance like zakat, sadaqat, and waqf. Figure 2 illustrates the roadmap that could be adopted to align the practice of Islamic finance to Maqasid Al-Shariah. Figure 2 shows that Maqasid Al-Shariah can be adopted in Islamic finance via merging the concept of SDGs, circular economy, impact investing, ethics, and VBI. Laldin and Furqani (2013, p. 278) explored the dimensions of Maqasid Al-Shariah in Islamic finance industry by investigating the ends (maqasid) and the means (wasa’il) and they have concluded that there are three specific maqasid in Islamic finance: wealth circulation, fair and transparent financial practices and justice at the micro and macro level and to these, the Shari’ah provides means (wasa’il) such as facilitating financial contracts, establishing values and standards and instituting social responsibility. In moving forward, Islamic financial institutions need to adopt yardsticks that would quantify the extent in which Maqasid Al-Shariah is achieved. The recommendations that are put forth in this regard are: • Shariah governance mechanisms applicable to Islamic finance need to be re-enacted with application of Maqasid Al-Shariah as part of it. A rubric must be formulated in this regard to check the level of Maqasid Al-Shariah each of the institution has achieved at the end of the year and this must be disclosed in the annual reports or must be made available to public. • In the terms and reference of Shariah scholars sitting in the Shariah Supervisory Boards or Shariah Advisory/Committees or board, there is a need to include assessing the impact of the products/services approved from Maqasid Al-Shariah approach to

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Adopt Maqasid al-Shariah Approach in endorsing Islamic finance products

Align Islamic finance with VBI

Align Islamic Finance with SDGs

Align Islamic finance with Ethics

Align Islamic finance with circular economy

Align Islamic finance with Impact Investing

Fig. 2 Proposed roadmap to align practices of Islamic finance to Maqasid AlShariah (Source Author’s own)

ensure that the products/services approved are not merely Shariahcompliant; but it also benefits the society. • The Maqasid Al-Shariah approach in Islamic commercial finance and Islamic social finance products/services need to have two sets of rules that ought to be checked and the standard-setting bodies of Islamic finance and the regulatory authorities need to join had for this and formulate the approaches that could be used by differentiating the two.

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• The education institutions that teach Islamic finance need to amend their syllabus by developing and introducing a full-fledge subject on Maqasid Al-Shariah where the theoretical and practical approaches taken could be taught to ensure that the next generation of Islamic finance professionals would be equipped with the knowledge of Maqasid Al-Shariah required for implementation of it in the Islamic finance industry paving way toward to the creation of a full-fledge Islamic monetary system. • To ensure that implementation of Islamic Muamalat does not stop at an Islamic financial system and it goes beyond that where a proper Islamic monetary systems are established in different countries of the world, it is imperative to move away from mere Shariah compliance test in its most basic form and move toward incorporation of Maqasid Al-Shariah-based value-based intermediation approach that will ensure the establishment of a comprehensive ecosystem required for Islamic financial system creating Islamic monetary systems with 100% Islamic institutions and tools. • The quality of Islamic finance products/services need to be measured in the light of Maqasid Al-Shariah and as such, in those jurisdictions in the annual reports the annual declaration of the Shariah Supervisory Boards or Shariah Advisory Committees are disclosed, it should be a requirement for them to disclose the quality of the Islamic finance products/services offered by the institution in the light of fulfilling Maqasid Al-Shariah. • The Board of Directors of Islamic financial institutions need to be given proper training on Maqasid Al-Shariah approach of enhancing Islamic finance products and services in the hope that from a cooperate governance perspective, it will be included in the governance mechanisms of the companies. This is important as these days, profitability is not the only requirement to understand the success of a corporation; there are other factors as well such as measuring the social and environment impact it has created. In this regard, Sheng (2013) has observed that Islamic finance is aligned toward social enterprise and the formation of shared value within society and to achieve social impact investing for social efficiency, sustainability, and stability, Islamic finance necessitates a resilient kind of governance, part from the oversight role of the Shariah bodies that achieve Shariah compliance.

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• Instead of using debt-based transactions in Islamic finance, equitybased financial in its true sense need to be promoted. Furthermore, for those who are in need, a mechanism to obtain qard al-hasan need to be created. This is imperative to ensure that Islamic finance cater for all segments of population irrespective of the social standing them. In this regard, the example of Jordan Islamic Bank is good to be adopted. In some of the jurisdictions like Malaysia, more reliance has been on commodity Murabahah or tawarruq-based products in Islamic banking and as such, introducing alternative products that aligns with Maqasid Al-Shariah need to be though looked at. Economic substance of the products need to be emphasized than merely complying the product structure and documents with Shariah.

5

Conclusion

Islamic finance is based on Shariah principles. It is evident from the foregoing discussion made that it is imperative to redefine Islamic finance in the light of Maqasid Al-Shariah and if this is successfully done, there would be the positive impact that it creates the society and the environment as well. It is clear from this research there is a gap in implementing Maqasid Al-Shariah in Islamic finance and there is a need to formulate a road map to fill this gap. It is recommended in this research that Maqasid Al-Shariah can be adopted in Islamic finance via merging the concept of SDGs, circular economy, impact investing, ethics, and VBI. Since inception of Islamic finance, the focus of Islamic finance has been to achieve Shariah compliance and now it is the right time to focus beyond that by ensuring that Maqasid Al-Shariah in achieving Maqasid Al-Shariah. It is anticipated that the outcome of this research will assist the stakeholders of Islamic finance to consider redefining Islamic finance from Maqasid Al-Shariah approach to provide value addition to the society and the environment and moving toward the right direction to create a full-fledge halal ecosystem with Islamic monetary system.

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References Abu Hurayra, M. (2015). Achievement of Maqasid-al-Shari‘ah in Islamic banking: An evaluation of Islami Bank Bangladesh Limited. Global Journal of Computer Science and Technology: A Hardware and Computation, 15(1), 9–16. Al-Ghazali, M. (1998). al-Mustasfa min ‘ilm al-usul. Dar al-Kutub al ‘Islamiyyah. Al-Mubarak, T., & Osmani, N. M. (2010). Applications of Maqasid al-Shariah and Maslahah in the Islamic banking practices: An analysis. Online at: https://www.researchgate.net/publication/235988767_Applications_of_ Maqasid_al-Shariah_and_Maslahah_in_the_Islamic_Banking_Practices_An_ Analysis. Accessed 17 June 2020. Auda, J. (2008). Maqasid al-Shariah: An introductory guide. Online at: https:// www.jasserauda.net/new/pdf/maqasid_guide-Feb_2008.pdf. Accessed 17 June 2020. Bank Muamalat Malaysia. (2019). Annual report 2019. Online at: https://www. muamalat.com.my/financials/. Accessed 28 June 2020. Bank Negara Malaysia (BNM). (2018). Value-based intermediation: Strengthening the roles and impact of Islamic finance. Online at: https://www.bnm. gov.my/index.php?ch=57&pg=137&ac=612&bb=file#:~:text=Value%2Db ased%20intermediation%20(VBI)%20aims%20to%20deliver%20the%20intende d,returns%20and%20long%2Dterm%20interests. Accessed 17 June 2020. CFA Institute. (2019). Sustainable, responsible, and impact investing and Islamic finance, similarities and differences. Online at: https://www.cfainstit ute.org/-/media/documents/survey/sri-investing-and-islamic-finance.ashx. Accessed 27 June 2020. Chapra, M. U. (2008). The Islamic vision of development in the light of Maq¯ asid Al-Shar¯ı‘ah. Online at: https://www.researchgate.net/publication/303499 103_The_Islamic_Vision_of_Development_in_the_Light_of_Maqasid_Al-Sha ri’ah. Accessed 17 June 2020. CIMB. (N/A). Sustainability. Online at: https://www.cimb.com/en/sustainab ility/sustainability.html. Accessed 28 June 2020. Global Impact Investing Network. (N/A). What you need to know about impacting investing. Online at: https://thegiin.org/impact-investing/needto-know/#what-is-impact-investing. Accessed 27 June 2020. Hassan, M. K., Sarac, M., & Alam, A. M. (2020). Circular economy, sustainable development, and the role of Islamic finance. Presented at 12th International Conference on Islamic Economics and Finance. Islamic Development Bank (IsDB). (2019). Islamic Development Bank/IFRC to launch a new fund to combat cholera. Online at: https://www.isdb.org/ news/islamic-development-bankifrc-to-launch-a-new-fund-to-combat-cho lera. Accessed 28 June 2020.

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Istanbul International Center for Private Sector in Development (IICPSD) and United Nations Development Programme (UNDP). (2014). Islamic finance and impact investing, IICPSD/UNDP. Jalil, A. (2006). The significances of Maslahah concept and doctrine of Maqasid (objesctives) Al-Shari’Ah in project evaluation. The Journal of Muamalat and Islamic Finance Research (JMIFR), 3(1), 171–202. Jordan Islamic Bank. (2016). Social responsibility report 2016. Online at: http:// ftp.jordanislamicbank.com/sites/default/files/SAMEER%20REPORT% 20Eng.pdf. Accessed 28 June 2020. Jordan Islamic Bank. (2019). Social responsibility report 2019. Online at: https://www.jordanislamicbank.com/sites/default/files/Social%202019% 20_eng.pdf. Accessed 28 June 2020. Kamali, M. H. (2008). Shariah law: An introduction. Oneworld Publications. Khan, T. (2019a). Reforming Islamic finance for achieving sustainable development goals. Journal of King Abdulaziz University, Islamic Economics, 32(1), 3–21. Khan, T. (2019b). Venture waqf in a circular economy. ISRA International Journal of Islamic Finance, 11(2), 187–205. Khan, T., & Mohomed, A. B. R. N. (2017). Ethical banking and Islamic banking: A comparison of Triodos Bank and Islami Bank Bangladesh Limited. Islamic Economic Studies, 25(S), 111–154 Laldin, M. A., & Furqani, H. (2013). Developing Islamic finance in the framework of maqasid al-Shari’ah: Understanding the ends (maqasid) and the means (wasa’il). International Journal of Islamic and Middle Eastern Finance and Management, 6(4), 278–289. Obaidullah, M. (2020a). Setting a Maqasid-driven development agenda for Islamic finance–III . Online at: https://sadaqa.in/2020/06/14/settinga-maqasid-driven-development-agenda-for-islamic-finance-iii/. Accessed 17 June 2020. Obaidullah, M. (2020b). Setting a Maqasid-driven development agenda for Islamic finance–I . Online at: https://sadaqa.in/2020/06/02/setting-a-maq asid-driven-development-agenda-for-islamic-finance/. Accessed 17 June 2020. Ougoujil, S., & Rigar, S. M. (2018). Ethical finance and Islamic finance: Particularities, possible convergence and potential development. International Journal of Economics and Management Engineering, 12(7), 958–972. Principles for Responsible Investment (PRI). (N/A). About the PRI . Online at: https://www.unpri.org/pri/about-the-pri. Accessed 28 June 2020. Principles for Responsible Investment (PRI). (2017). Islamic finance and responsible investment. Online at: https://www.unpri.org/asset-owners/islamic-fin ance-and-responsible-investment/610.article. Accessed 28 June 2020.

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RFI Foundation and Islamic Financial Services Board. (2019). Responsible finance ethical and Islamic finance meeting the global agenda. Online at: https://ceif.iba.edu.pk/pdf/Responsible_Finance_Ethical_and_Islamic_F inance_Meeting_TheGlobal_Agenda.pdf. Accessed 17 June 2020. Rosly, S. A. (2015). Maqasid al-Shariah and the legality of Islamic financial contracts. Online at: https://www.inceif.org/kmimpact/2015/04/23/maq asid-al-Shariah-and-the-legality-of-islamic-financial-contracts/. Accessed 17 June 2020. Sheng, A. (2013). Islamic finance as social impact investing. Fung Global Institute, Asian Perspective Global Issue (Issue Brief 2013/08, 1–6).

CHAPTER 3

Pandemic Crisis, Digitalization and Social Responsibility: An Emerging Role of Islamic Economics and Finance M. Kabir Hassan, Aishath Muneeza, and Ashraf Khan

1

Introduction

Islamic economics and finance derived its axioms from Shariah. Irrespective of the faith convictions, Islamic economics and finance has gained momentum in the world today. It is reported that by 2024, the global Islamic finance industry assets will reach USD$3.69 trillion and in 2019, it is estimated that Muslims have spent USD$2.02 Trillion on

M. K. Hassan (B) University of New Orleans, New Orleans, LA, USA e-mail: [email protected] A. Muneeza School of Graduate and Professional Studies, INCEIF, Kuala Lumpur, Malaysia e-mail: [email protected] A. Khan Institute of Business Administration, Karachi, Pakistan e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8_3

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halal sectors inspired by ethical consumption needs while it is anticipated that by 2024, this amount will reach to USD$2.4 Trillion at a five-year cumulative annual growth rate of 3.1% (Dinar Standard, 2020). It is also forecasted that there will be 8% decrease in global Muslim spending in 2020 due to pandemic on sectors covered by report published by Dinar Standard (2020) which are food, pharmaceutical, cosmetics, fashion, travel and media/recreation sectors. It is also anticipated that except for travel sector, all the other sectors covered by Dinar Standard (2020) will return to pre-pandemic spends level by the end of 2021. Islamic economics and finance can be described as the economics and finance which are consistent with Islamic principles. The key drivers behind the growth of Islamic economics and finance include a large number of Muslim population, the drive to have ethical consumption and the political drive in different countries to have strategies to have halal products and services (Dinar Standard, 2020). Through the pandemic has created disruption in Islamic economics and finance, there is no doubt that Covid-19 has transformed the Islamic finance and economy by escalating the process of adoption of technology (Dinar Standard, 2020) and making it more aligned towards social finance where serving humanity has become a priority. The developments of Islamic economics and finance in different countries are at different levels. According to Global Islamic Economy Indicator (GIEI), Malaysia is ranks number one followed by Saudi Arabia, United Arab Emirates (UAE) and Indonesia (Dinar Standard, 2020). As such, the effect of the pandemic on Islamic economics and finance is not the same for all countries in the world. The impact of Covid-19 on Islamic economics and finance need to be explored to shape its future. Therefore, this is an exploratory research which is conducted to find out the ways in which the scope of Islamic economics and finance could be redefined in the light of the pandemic considering the impact it has made on Islamic economics and finance. There is no doubt that the pandemic has made the whole world realised the significance of digitalization and social responsibility in economics and finance and this is the case in Islamic economics and finance too. For instance, OECD (2020) states that prior to the pandemic, social economy is used to fix or repair social issues or problems; but the pandemic has transformed the concept of the social economy to include a more inclusive and sustainable economy and society. It is also evident that the pandemic has escalated digitalization for consumers and businesses as well where the

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consumers have demanded more online transactions leading businesses to go digital (Dali et al., 2020). This paper consists of five sections. Followed by this introduction, section two discusses the effect of the pandemic on Islamic economics and finance while section three deals with the ways in which they cope of Islamic economics and finance can be redefined in the light of the pandemic. Section four presents the recommendations followed by the last section, which is the conclusion. There is a need to utilise the pandemic as an opportunity to “steer the world towards a more sustainable and inclusive, resilient and low-emissions future” (United Nations, 2020).

2

Effect of Covid-19 on Islamic Economics and Finance

The effect of the pandemic on Islamic economics and finance can be analysed from the perspectives of different industries. There is no doubt that though the pandemic began as a health crisis, it has disrupted all the economic activities in the world as the lockdown measures taken by the countries in the world to save humankind from the contagious virus has saved the lives of the humankind but the economic lifelines has been disrupted. In this section of the paper, the effect of the pandemic on different sectors of Islamic economics and finance will be explored. Dinar Standard (2020) discusses the impact of pandemic on different sectors of Islamic economics including Islamic finance. Table 1 summarises the main findings of Dinar Standard (2020) in this regard. It is imperative to understand the impact of pandemic on three main dimensions: that is from the perspective of the customers, institutions and economies including the society in which the Islamic economics and finance services and products are offered. From the perspective of the customers, the pandemic has decreased their spending power either due to change in their job status affecting salary or due to unavailability of the right platform to demand the products and services they want especially in the beginning of the pandemic where electronic commerce platforms or social business platforms were not available. For instance, Jones (2020) states that consumer spending has been changed by the pandemic just like other aspects of our lives and due to lockdown measures, spending of consumers in all industries in general have decreased as air travel has been suspended and shops/restaurants have been closed down. Not only

Sector

Media

1.

• A positive impact was evident on media industry due to the pandemic as opportunity in online media increased • However, due to pandemic, media industry hit hard as there was cancellation of live events and physical production • Due to lockdown, the Muslim consumer’s attention for online media grew and demand for certain Muslim media products increased exponentially. For instance, Turkish series Dirili¸s: Ertu˘grul caught the attention of millions of viewers resulting in dubbing the series in other languages and Malaysia launched Nurflix and Saudi Arabia had put efforts via its Ministry of Culture to attract investors to invest in this sector • In 2019, it is projected that the amount spent by Muslim consumers on media and recreation is at USD$222 billion • However, in 2020, it is expected to decrease to UDF$214 billion prior to bouncing back to the level of development seen in 2019 in 2021 • It is also estimated that the Muslim consumer’s expenditure on this sector will increase at a 5-year CAGR of 3.9% from 2019 to 2024 reaching USD$270 billion in 2024

Details

Impact of Pandemic on Islamic economics and finance

#

Table 1

38 M. K. HASSAN ET AL.

Sector

Halal Cosmetic Industry

Pharmaceuticals

#

2.

3.

(continued)

• In the midst of the pandemic even more consumer industry producers (such as Cosmecca Korea and Brazil’s Biozer) obtained halal certification for their products and entered the halal cosmetic industry in countries like Indonesia • New e-commerce platforms were introduced too. Indonesia’s new cosmetics e-commerce platform, Sociolla, raised $40 million in its latest venture capital funding round. Luxury halal cosmetics products from UK brand Baroque & Rose featured in gift bags handed out at the 2020 Golden Globes’ awards, while multinational Nivea launched halal-certified creams and sprays during Ramadan in Indonesia • For sales and marketing, the pandemic forced the companies in this sector to go into digital and e-commerce platforms to increase sales • In 2019. The Muslim consumers demand halal cosmetics increased 3.4% which is to USD$66 billion. • In 2020, it is expected to drop by 2.5% • It is anticipated that the demand for Muslim consumers will increase at a 5-year CAGR of 2.9% to reach $76 billion by 2024 • The pandemic has increased the demand for halal certified pharmaceuticals (such as drugs and medical devices) as improvising health and immunity have become a priority at international, national and household levels too • The pandemic has paved way for the development of telemedicine sector too. For instance, USD$40 million was raised for Vezeeta, the health care app used in Egypt • In 2019, expenditure made by Muslim customers on pharmaceuticals was at USD$94 billion and in 2020, it is expected to decrease to USD$87 billion • It is anticipated that the sector will grow at a CAGR of 2.3% between 2019 and 2024 to USD$105 billion

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Sector

Modest Fashion

4.

(continued)

#

Table 1

• The pandemic forced many small businesses in this sector to close down though prior to pandemic favourable developments were taking place at a fast pace • E-commerce and social commerce became essential to the sector • It is expected this industry to recover at a slow pace and recovery will only be possible with a resilient ecosystem where sustainable financing options are made possible • In 2019, it is estimated that the spending made by Muslims on apparel is at USD$277 billion • In 2020, it is expected to decrease by 2.9% to USD$268 billion • It is estimated that the spending of Muslims on apparel will increase at a 5-year CAGR of 2.4% from 2019 to 2024 to reach $311 billion in 2024

Details

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Sector

Travel and Tourism

Halal Food

#

5.

6.

(continued)

• The pandemic has halted the travel and tourism industry completely and it has created challenges in commencing the operations in the manner it was in pre-pandemic • Global events such as Tokyo Olympics were postponed while airlines became bankrupt adversely affecting the hospitality industry • In 2020, the biggest worship gathering of Muslims, the Hajj (pilgrimage) to Saudi Arabia from other countries were cancelled while Umrah was also postponed during the year for a long interval • In the travel technology area, investors invested in pandemic showing their interest in investing for long-term profitable areas in this sector. For instance, USD$250 million was raised in July 2020 in the midst of the pandemic by Indonesia’s Traveloka raised while Pigijo also from Indonesia which is a travel company has raised USD$861,000 in its initial public offering • In the year 2019, it was recorded that the Muslim consumers appending on travel increased by 2.7% which is to USD$194 billion • However, in 2020 it is expected to fall to USD$58 billion before convalescing to pre-pandemic levels by 2023 increasing at a 5-year CAGR of 1.4% from 2019 to 2024 • Digitalisation process is escalated in halal food industry due to the pandemic • With the publishing of key halal standards by Standards and Metrology Institute for Islamic Countries (SMIIC), the halal food industry had the opportunity to standardise their regulations • Financing opportunities for halal food small and medium enterprises (SMEs) were launched in countries like Malaysia by CIMB Islamic and Standard Chartered Saadiq • In 2019, the Muslims spending on halal food increase by 3.1% 9 from USD$1.13 trillion to USD$1.17 trillion • In 2020, it is expected to decrease slightly and is expected to reach USD$1.38 trillion in 2024 at a 5-year CAGR of 3.5%

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Islamic Finance

7.

Source Dinar Standard (2020)

Sector

(continued)

#

Table 1

• Efforts were made by countries to develop their legal and regulatory framework to enhance Islamic finance • For instance, United Arab Emirates (UAE) has commenced an initiative to create a global legal and regulatory Islamic finance framework • Indonesia, Kuwait and Qatar have also introduced new regulations on Islamic finance • Islamic banking and takaful sectors were adversely affected; but the assets of Islamic finance is expected to remain the same as in 2019 in 2020 which is at USD$2.88 Trillion • Opportunities in fintech was evident in the midst of the pandemic where the efforts in this regard was escalated

Details

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this, but the economic uncertainties created within households have made them reluctant to spend more and their strategy is to save more to ensure that they survive the household income decrease that could happen due to a pandemic (Jones, 2020). Further, the forced lockdown inside the houses has changed the spending habits of consumers more to groceries and entertainment that could be enjoyed inside homes (Jones, 2020). In short, it is not only the amount which is spent by the customers which is changed due to pandemic, but the products and services demanded and their saving culture too. As such, some believe that the pandemic has forcefully taught the consumers to spend responsibly (Hamid, 2020). The undeniable truth is that the pandemic has adversely affected the livelihood of people and their health and the food system too (World Health Organization, 2020). The impact of the pandemic on those individuals who has taken loans/financing facilities from financial institutions, due to change in their financial circumstances, some are unable to meet their financial commitments including the loans/financing facilities from financial institutions and as such, debt moratoriums and extended financial assistance are extended to them (National Consumer Law Center & Americans for Financial Reform Education Fund, 2020). As for the institutions providing products and services in the economy, the impact of the pandemic depends on the sector in which they are. For instance, if they are in the travel and hospitality industry, definitely, the impact of the pandemic is much more adverse than any other sector especially in the beginning of pandemic where lockdown measures have completely shut down the industry and the same can be observed in food and beverage industry too where the consumers have opted for things that could be consumed inside homes due to pandemic (FocusM, 2020). The global supply chain has been disrupted and due to this especially at the initial stage of the pandemic, there were miscommunication among the suppliers leading to hiccups in the industry where the institutions providing products and services could not meet their contractual obligations (PWC, 2020) leading to bankruptcy or huge financial losses leading to the redundancy of workers or termination of workers to reduce the overhead costs in a quest to manage their cash flow. It is essential to note that these impacts on the institutions will depend on their level of establishment as well. For instance, for small businesses the impact of the pandemic will be more adverse than those established and financial relief programmes (like stimulus packages) provided by the respective governments could bail out them from the situation either temporarily

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or in long-term basis (Bartik et al., 2020). The impact of the pandemic on those business institutions who has taken loans/financing facilities from financial institutions, due to change in their financial circumstances, some are unable to meet their financial commitments including the loans/financing facilities from financial institutions and as such, debt moratoriums and extended financial assistance are extended to them. If the institutions in this case are the financial institutions, they are being given assistance by the central banks and the governments to survive the pandemic at the same time balancing the welfare of their customers whose financial position has become weak due to the pandemic. The effect of the pandemic on economies including the society is adverse as when the spending power of the consumers are adversely affected and the institutions operating in the economy face financial hiccups to survive and depend on the government to give financial aids via stimulus packages. As such, fiscal deficit is a situation that is hard to avoid. It is reported that fiscal response to the pandemic has already reached nearly USD$11 trillion globally and global debt has risen to exceptional levels, reaching USDS$258 trillion or 331% of the global GDP in the first quarter of 2020 (United Nations, 2020). Furthermore, the social status of the members of the community is also changed due to pandemic where it is said that the pandemic has turned back the poverty clock where due to high rates of unemployment the crime rate in the societies have increased (Tang, 2020) leading to a situation where the only entity who could provide a financial relief to them is the government (Letzing, 2020). Therefore, the fiscal deficit situation of the government is further exacerbated due to this. For example, it is reported that the public debt of the government of United States of America has increased to the extent it reached during the time of Second World War (Letzing, 2020). Therefore, instead of relying on conventional ways to resolve the sovereign debt crisis, alternative new ways through Islamic finance could be the answer for this.

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3 Redefining the Scope of Islamic Economics and Finance in the Light of Effects of the Pandemic The pandemic has taught the mankind numerous lessons. As such, learning from these lessons and shaping the future is within the hands of humans. In relation to the effects of the pandemic on Islamic economics and finance, it is imperative to redefine the scope of it to ensure that the existing system of Islamic economics and finance in the world are resilient enough to withstand the post-pandemic and any future such black swan event. Instead of revolving around the notion of Shariah compliance alone, there is a need to redefine the scope of Islamic economics and finance using maqasid al-Shariah (objectives of Islamic law). Maqasid al-Shariah in general refers to promoting anything which is beneficial to humankind while eliminating any kind of harm that could be detrimental to humankind (Gwadabe & Ab Rahman, 2020). The difference between in achieving mere Shariah compliance rather than achieving maqasid al-Shariah is that in achieving Shariah compliance, one will try to validate the transactions conducted from an Islamic perspective and justify them from that perspective without gauging the effect or the impact of those products on the society or economy. This means that if riba (interest) is not found in a financial transaction, in the current practice, it is sufficient to say the financial product or service is Shariah compliant and if a maqasid al-Shariah approach is used, the socio-economic perspective of the product will be weighed to check prior to the launching of it. This will warrant a macro analysis of the whole transaction of product and services to derive a conclusion by relating it to socio-economics and as such, value-based intermediation approach will be adopted by the Islamic economics and finance stakeholders going beyond Shariah compliance. The pandemic has taught the world that commercial economics and finance products and services are not compatible to provide financial relief to those who are in need for financial assistance to survive in the world. The humanising of finance is something that needs to be embedded in Islamic economics and finance in future. Prior to the pandemic, Islamic social finance was not given so much attention in the mainstream of Islamic economics and finance. As such, in the midst of the pandemic when Islamic social finance is required to be used, there was no enabling ecosystem including the required legal, regulatory and governance framework put in place in many countries as only few commercial financial

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institutions had activated zakat (alms), sadaqat (charity), waqf (endowment) and qard (interest-free loans) to be used under one roof. The rest of the financial institutions believed that these instruments and institutions should be used by the informal economic sector or the third sector of the economy and they have no role to play. But soon they realised that the debt moratoriums granted to the customers could not resolve the debt issues of customers and they require a helping hand which could only be provided via zakat or sadaqat or qard which were mechanisms that are not available in the financial institutions. Therefore, the pandemic has taught the Islamic economics and finance stakeholders to redefine it by converging Islamic commercial economics and finance with Islamic social economics and finance for the benefit of whole mankind with the objective of humanising it. The pandemic has also taught that the future of Islamic economics and finance should be provided in a socially and physically distant manner. As technology has no religion and since this is the era of Industry 4.0, Islamic economics and finance need to be redefined using technology embedded within it in all aspects of it. Prior to the pandemic, the adoption of technology in Islamic economics and finance was slow and this process has escalated due to the pandemic which forced the Islamic economics and finance stakeholders to bring and adapt to survive. As necessity is the mother of invention, the pandemic necessitated the use of technology in all aspects of our lives including in the finance industry. From normal internet-based services to use of sophisticated technologies such as blockchain technology and artificial intelligence is being considered in Islamic economics and finance industry today. As such, Shariah tech could be an area that would need future attention and development to pave the way to use technology to achieve Shariah compliance in the financial transactions performed. In short, it could be stated that the pandemic has taught us to redefine Islamic economics and finance to pave way to converge social responsibility and digitalization in it.

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4 Recommendation: Towards Convergence of Digitalization and Social Responsibility in Islamic Economics and Finance This paper recommends Islamic economics and finance to be redefined realigned with maqasid al-Shariah by converging it with social responsibility and digitalization. Figure 1 illustrates in a nutshell how this redefining of Islamic economics and finance could be achieved. As shown in Fig. 1, in the proposed Islamic economics and finance version 2.0, maqasid al-Shariah as a whole will be given consideration in implementing Islamic economics and finance where society, economy and environment impact will be assessed in addition to Shariah compliance.

Maqasid alShariah Socio-economic impact of all the products and services will be measured in addition to Shariah compliance requirements checked. This will include environment impact too.

Islamic Economics & Finance 2.0

Digitalization

Technology will be linked to improvise Islamic economics and finance. For instance, Digital payment, digital financing, blockchain technology, artificial learning and machine learning, big data could be used.

Social Responsibility In all industry of Islamic economics including Islamic finance, social segments will be introduced. For instance, in halal cosmetics, not only the commercial audience will be considered; but the social sector of it will also be launched.

Fig. 1 Way to achieve convergence of social responsibility and digitalization in Islamic economics and finance (Source Author’s own)

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In the pandemic, what is meant by application of maqasid al-Shariah is different as there are different views expressed by scholars in this regard. For instance, Mohamed and Ismail (2020) state that from the perspective of an individual during the pandemic, the individual shall only spend money on what is essential (darurat), but not on luxury (tahsiniyyat) items. They believe that those individuals whose income is not adversely affected during the pandemic will have to spend the surplus on those who need it in society via sadaqat or charity. They also believe that in the midst of the pandemic the individuals ought to realise the importance of sharing and the significance of maqasid al-Shariah more than ever whereby one shall protect the five basic essentials of maqasid al-Shariah which are religion, life, intellect, lineage, dignity and property. They believe that by giving to those who are in need, a win-win situation is created for both those who are in need and those who are having a surplus in the societies as this is the way in which one could rejuvenate the faith of humanity in societies in uplifting and empowering each other. Adil (2020) also states that charity funds can play a vital role in the midst of pandemic and maqasid al-Shariah and maslahah (public interest) ought to be given paramount consideration to help each other in the society to provide relief to each other. Furthermore, in September 2020, even the Prime minister of Malaysia, Tan Sri Muhyiddin Yassin also said that maqasid al-Shariah is the guiding principles for the government to fight against the pandemic (The Sun Daily, 2020) showing the importance of maqasid al-Shariah at policy making level as well. As such, convergence of maqasid al-Shariah with Islamic economics and finance is essential too. The issue in this regard is to understand what approach should be used to link maqasid al-Shariah with Islamic economics and finance. Instead of using a debtbased approach with riba which is used in the conventional economics and finance system, there is a need to re-link Islamic economics and finance to the real economic activity by striking a balance between assetbacked and debt-based finance by moving away from capitalistic way of managing economies (Benaicha, 2020). The United Nation’s sustainable development goals and circular economy principles need to be promoted (Khan, 2020) with value-based intermediation to ensure that the social impact of Islamic economics and finance owing to individuals, societies and economies are evident. Simultaneously, digitalization will be used by adopting the appropriate technology required for the situation. The process of digitalization in Islamic economics and finance has begun even before pandemic. For

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instance, it is reported that there are 127 fintech companies offering Shariah-compliant products globally where 27 of these companies are in the UK while 19 companies are in Malaysia; 15 companies are in the United Arab Emirates; 13 companies are found in Indonesia; 9 companies are in Saudi Arabia; and 9 companies are in the USA (Santosdiaz, 2020). There are eight types of technologies used for digital transformation: mobile, Internet of Things (IoT), cloud, digital twin, robotics, artificial intelligence and machine learning, augmented reality and additive manufacturing (White, 2019). There are numerous benefits of digitalization which include achieving business efficiency and productivity with automation and conservation of resources. In this regard, digital economy is also a concept used to describe the use of transformative technology in economic activities that consist of e-business, e-business infrastructure and e-commerce of which the main characteristics are measuring, tracking and analysis of data is possible via objects while communication in economic activities via technology has become faster, convenient and effective with sharing and personalization (Saini, 2020). The Islamic version of the digital economy is dubbed as Islamic digital economy (Thomson Reuters & Dinar Standard, 2015). There are various case studies of successful case studies of Islamic digital economy which was presented even before the pandemic and some of these case studies are: Halal Gems provides digital content for halal foods in an interactive manner where the best halal cuisines and restaurants around the globe is shown; Alchemiya is a premium online-based video-on-demand that provides video content about Muslim life; Ahli App is a functional tool and service where nearby Muslims are given information on where to gather for congregation prayers based on their location; Islamic digital business to business (B2B) services include Zilzar which is a product market place which also developed a strategic partnership with MasterCard and initiated Zilzar Life Digital Magazine with the objective of connecting millennials who are around the globe; Muslim Ad Network is an online advertising platform; Halalpage.com.my is an online directory that provides a reference guide of halal companies; and Launchgood is a commerce and exchange platform where USD$3 million is crowdfunded connecting Muslims around the world who are consumers and entrepreneurs (Thomson Reuters & Dinar Standard, 2015). The proposed way in which the social responsibility can be achieved is via activating social segment in all sectors of Islamic economics. For example, in all sectors of Islamic economics, Islamic social finance tools

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such as zakat, sadaqat and awqaf will be activated and there will be a mechanism established to assist the poor and needy or anyone who cannot afford the expensive products or services. For example, the halal food providers could establish soup kitchens or food sharing mechanisms by individually or combining with others who provide similar services in the market like Kechara soup kitchen (Kechara, n.d.). In doing this, instead of having a physical place, using internet of things (IoT) food can be collected and can also be distributed to those who are in need of it. Likewise, dress rental services at an affordable price could be a service that could be provided for those who cannot afford to buy the expensive dresses for specific occasions such as job interviews where dressing properly is essential for a successful interview. One of these initiative is “Dress for Success” initiative (Dress of Success, n.d.). Using technology, even this service can be provided to those in need without physically visiting the shops. Likewise, express online financing services could also be provided for those who are in need of immediate cash to survive and in this process within Shariah parameters a rahn (valuable asset of the debtor taken by the creditor until the loan given is paid off as a security which will be sell-off to realise the loan money if the debtor is unable to pay the loan as promised). To facilitate the implementation of what is shown in Fig. 1, it is imperative to enact a strategic plan as well as the enabling framework for that by the respective countries. At policy level, there is a need for the respective countries to ensure that digital banking is promoted while economics and finance products and services are provided in a socially and physically distant manner. In this regard, e-KYC rules will be imperative to be enacted while laws on digital signature and cybersecurity laws are required to be adopted as well. The most important requirement in this regard could be to make internet available at an affordable manner to all in the country. In terms of challenges, there are many challenges identified in establishing a digital economy which include: unreliable postal services; lack of digital payment system; lack of creative marketing digital Islamic talent; lack of web development and mobile coding skills in Organisation of Islamic Cooperation (OIC) countries; and finding commercially viable business models (Thomson Reuters & Dinar Standard, 2015). Relying on US dollars is also something that needs to be reconsidered as well. Ways to overcome these challenges need to be deliberated to ensure that there is sustainability in digitalization of Islamic economics and finance not only domestically, but internationally as well.

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Conclusion

The pandemic has been described as twin threats to humans: that is to the lives and livelihoods (McKinsey & Company, 2020). Islamic economics and finance which derives its values from Shariah has the potential which is untapped that could be improvised to ease the countries who are economically and financially suffering from the pandemic. This paper proposes a way in which Islamic economics and finance can be redefined by merging it with maqasid al-Shariah, digitalization and social responsibility. There is no doubt that the pandemic created the opportunity to escalate the convergence of digitization and social responsibility in the light of maqasid al-Shariah. It is anticipated that the findings of this research will assist the key stakeholders of Islamic economics and finance such as policy makers, academicians, researchers and practitioners to shape the future of Islamic economics and finance that would be aligned more towards achieving maqasid al-Shariah (objectives of Islamic law), rather than merely rotating around the notion of Shariah compliance in isolation. There is no doubt that the pandemic has exposed the vulnerable side of individuals, societies and economies which has warranted redefining Islamic economics and finance in the light of maqasid al-Shariah by converging social responsibility and digitalization emphasising on social responsible and digital literacy at global context.

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Dinar Standard. (2020). 2020/2021 state of the global Islamic economy report. https://cdn.salaamgateway.com/reports/pdf/862e1c9a9d925c5cd6 aacae31b0ea102e21778a9.pdf. Dress for Success. (n.d.). Who we are? https://dressforsuccess.org/about-us/ who-we-are/. FocusM. (2020). Change in consumer spending pattern due to Covid-19. Focus Malaysia. https://focusmalaysia.my/featured/change-in-consumer-spendingpattern-due-to-covid-19/. Gwadabe, N. A., & Ab Rahman, A. (2020). The role of Islamic finance in mitigating the economic impact of Covid-19 towards the attainment of Maqasid al Shariah: A case study of waqf institutions in Kano state, Nigeria. The Journal of Muamalat and Islamic Finance Research, 17 (Special Issue), 59–70. Hamid, M. A. A. (2020). Covid-19 forcing consumers to spend responsibly. New Straits Times. https://www.nst.com.my/opinion/columnists/2020/06/597 236/covid-19-forcing-consumers-spend-responsibly. Jones, K. (2020). These charts show how COVID-19 has changed consumer spending around the world. World Economic Forum. https://www.weforum. org/agenda/2020/05/coronavirus-covid19-consumers-shopping-goods-eco nomics-industry. Kechara. (n.d.). About us. https://www.kechara.com/soup-kitchen/about-us/. Khan, F. (2020). Sustainable development for real economy: Some lessons from the 12th ICIEF. Daily Sabah. https://www.dailysabah.com/opinion/op-ed/ sustainable-development-for-real-economy-some-lessons-from-the-12th-icief. Letzing, J. (2020). Countries are piling on record amounts of debt amid COVID-19: Here’s what that means. World Economic Forum. https://www. weforum.org/agenda/2020/11/covid-19-has-countries-borrowing-moneyjust-about-as-quickly-as-they-can-print-it/. McKinsey & Company. (2020). Covid-19: Implications for business. https:// www.mckinsey.com/business-functions/risk/our-insights/covid-19-implicati ons-for-business. Mohamed, S. F. S., & Ismail, S. (2020). Implementing Maqasid al-Shariah during COVID-19 pandemic. Universiti Sains Islam Malaysia. https://www. usim.edu.my/news/in-our-words/implementing-maqasid-al-shariah-duringcovid-19-pandemic/. National Consumer Law Center and Americans for Financial Reform Education Fund. (2020). COVID-19 crisis: Consumer financial protection policy recommendations. https://www.nclc.org/images/pdf/special_projects/covid19/IB_NCLC_AFR_Covid_Consumer_Recommendations.pdf. OECD. (2020). OECD policy responses to coronavirus (COVID-19): Social economy and the COVID-19 crisis: Current and future roles. http://www. oecd.org/coronavirus/policy-responses/social-economy-and-the-covid-19-cri sis-current-and-future-roles-f904b89f/.

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PWC. (2020). COVID-19: Operations and supply chain disruption. https:// www.pwc.com/us/en/library/covid-19/supply-chain.html. Saini, S. (2020). What is digital economy? Meaning, advantages and disadvantages. Finance n Insurance. https://financeninsurance.com/digital-eco nomy/. Santosdiaz, R. (2020). Islamic finance in the global digital economy. The Fintech Times. https://thefintechtimes.com/islamic-finance-in-the-global-dig ital-economy/. Tang, A. (2020). Covid-19: Rise in unemployment will lead to higher crime rates, says Lee Lam Thye. The Star. https://www.thestar.com.my/news/nat ion/2020/06/13/covid-19-rise-in-unemployment-will-lead-to-higher-crimerates-says-lee-lam-thye. The Sun Daily. (2020). Maqasid syariah—Guiding principles govt’s fight against Covid-19—Muhyiddin. https://www.thesundaily.my/local/maqasid-syariahguiding-principles-govt-s-fight-against-covid-19-muhyiddin-XX4321303. Thomson Reuters and Dinar Standard. (2015). Digital Islamic economy: Special focus brief on the digital Islamic consumer services. https://www.dinarstandard. com/wp-content/uploads/2019/05/SALAAM14092015044145.pdf. United Nations. (2020). Financing for development in the era of COVID19 and beyond: Menu of options for the considerations of ministers of finance. Part I. https://www.un.org/sites/un2.un.org/files/part_i-_execut ive_summary_menu_of_options_financing_for_development_covid19.pdf. White, N. (2019). 8 commonly-used digital transformation technologies. https:// www.ptc.com/en/blogs/corporate/digital-transformation-technologies. World Health Organization. (2020). Impact of COVID-19 on people’s livelihoods, their health and our food systems: Joint statement by ILO, FAO, IFAD and WHO. https://www.who.int/news/item/13-10-2020-impact-of-covid-19on-people’s-livelihoods-their-health-and-our-foodsystems#:~:text=The%20e conomic%20and%20social%20disruption,the%20end%20of%20the%20year.

CHAPTER 4

Islamic Finance and SDGs: Connecting Dots Irum Saba, Ashraf Khan, and Haneeah Jawed

1

Introduction

The Islamic financial system encompasses Islamic banking, Islamic insurance, Islamic capital markets, and all other financial activities that are Shari’ah compliant. The resilience of the Islamic financial system stems from its differentiating features which include its direct link to the real economy because of its trade-based, asset-backed form of financing and the prohibition of interest (riba’) and any speculative activity. The Islamic financial and economic system is based on three main objectives: the eradication of wealth accumulation, laying the foundation for a sustainable and practicable economic system, and empowering everyone through a just and equitable allocation of resources (Usmani, 2015).

I. Saba · A. Khan (B) · H. Jawed Institute of Business Administration (IBA), Karachi, Pakistan e-mail: [email protected] I. Saba e-mail: [email protected] H. Jawed e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8_4

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The Islamic financial system is built on a foundation that promotes social fairness and justice, comprehensive welfare, and prosperity by empowering every individual of the society to actively contribute to economic growth and progress. In order to achieve these objectives, Shari’ah, the Islamic law has set out some ground rules for Islamic finance. Shari’ah compliant activities have to be free from elements that are prohibited by the Islamic law including interest (riba), gambling (qimar), speculation, and excessive uncertainty (gharar). Industries such as conventional banking, conventional insurance, pork and arms manufacturing, casinos, alcohol-related activities, pornography, etc., are also deemed forbidden (haram) in Shari’ah. Certain kinds of transactions like short selling, sale and buyback, selling without ownership and possession, selling debt, future contacts, etc., are invalid and prohibited. These rules have been prescribed to eradicate the concentration of wealth among the rich and to ensure that Islamic economies are free from inequality, greed, selfishness, oppression, and injustice, all of which are against the core essence of Islam (Saba, 2018). The financial crisis of 2008 brought attention to the loopholes in the conventional financial system. There was a gap for a framework that was not only robust enough to hold out against the horrors faced by the conventional banks at the time but was also ethically and socially beneficial. In 2008–2011, Islamic financing grew by 14.3% while deposits grew by 17.6% (IFSB, Islamic Financial Services Industry Stability Report, 2016). These double-digit growth figures highlighted the relative strength of the Islamic financial system. This system is gradually becoming popular in different parts of the world as people are beginning to realize its positive practical and ideological features. Because of its expansive scope, Islamic finance can suit the diverse needs of the global economy by providing products and services ranging from innovative solutions for neglected markets to tailored and customized offerings for complex financial requirements of the current advanced times (Siddiqui, 2013). 1.1

Islamic Banking

The Islamic banking sector is gradually attaining dominance in the global Islamic Financial Services Industry (IFSI). In many Muslim-majority countries, Islamic banking is growing faster than conventional banking. Islamic banking contributes up to 71% (USD 1.72 trillion) to the total

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assets of the Islamic finance industry, making it the largest segment. Besides commercial banking which is responsible for most of the sector’s growth, various wholesale and other kinds of banks also support the sector (Research & Markets, 2019). As of 2019, more than 1400 Islamic financial institutions are operating in over 70 countries (ICD-Refinitiv, 2019). Islamic finance is growing in global acceptance with regions of Middle East, US, Far East, Europe, Africa, South Asia, and Central Asia entering or having entered the industry. In 2018, the sector’s performance had a growth of 0.9% (IFSB, Islamic Financial Services Industry Stability Report, 2019). This indicates that in jurisdictions with dual financial systems operational, Islamic finance is gradually growing along with the demands and expectations from its services. It is expected that the global Islamic financial assets will have grown to USD 2.175 trillion by 2024. Standards and Poor has estimated the market capacity for Islamic banks to be USD 4 trillion, stating that they have the potential to serve 40–50% of Muslims worldwide in the next few years (Siddiqui, 2013). 1.2

Islamic Insurance

There are about 335 takaful institutions, including full-fledged takaful operators, takaful windows, and retakaful operators offering their products and services in at least 45 countries. The takaful industry is mostly concentrated in the regions of GCC, South-East Asia, Middle East and North Africa (MENA). These institutions offer various types of takaful products, with the majority offering general takaful and composite takaful followed by life takaful and retakaful. Many countries have now developed regulations specific to the takaful sector. In 2017, there was growth of 4.3% (USD 26.1 billion) in the total contributions of takaful markets. The contribution of this sector to the global IFSI stands at 1.3%. In 2018, global takaful assets amounted to USD 46 trillion and this figure is expected to grow to USD 65 trillion by 2024 (ICD-Refinitiv, 2019). The future outlook for takaful sector seems positive because most jurisdictions are recording a high retention ratio and a decline in their expense ratio. As the industry grows, the need for a strong regulatory framework becomes even more important. The industry is also progressing on this front by preparing for implementing IFRS 17, the new International Financial Reporting Standards for insurance. Stress testing and other measures to improve the professionalism of service providers are also being considered (IFSB, Islamic Financial Services Industry Stability Report, 2019).

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1.3

Islamic Capital Markets

The Islamic capital market has been developing over the years and now makes up about 27% (USD 591.9 billion) of the global IFSI assets. The main instrument dominating this sector is sukuk (Islamic bonds). This is because countries around the world are using sukuk to finance expenditures of the national budget through sovereign and multilateral issuances. Recently, there has also been an increase in the number of new markets issuing sovereign sukuk, including green sukuk to raise funds for environmentally sustainable projects (IFSB, Islamic Financial Services Industry Stability Report, 2019). In 2018, the total sukuk value outstanding was USD 470 billion contributed to by over 2800 sukuk including sovereign, quasi-sovereign, and corporate sukuk based on a variety of different structures but mainly Murabaha, Ijara, and Mudaraba. Another component of the Islamic capital markets, the Islamic equity indices were better in performance when compared to conventional benchmarks. The number of Islamic funds also rose to 1701 in 2018 holding a total value of USD 108 billion. This value is predicted to double to USD 216 billion by 2024 (ICD-Refinitiv, 2019). Significant investments in infrastructure, sukuk, and other promising sectors with growth potential and technological innovation in products and services being offered means that the global Islamic finance market is growing albeit moderately. All three main components of IFSI, Islamic banking, Islamic capital markets, and Islamic insurance, contribute to the growth of the industry. The global industry has expanded by up to 75% from USD 1.76 trillion in 2012 to USD 2.52 trillion in 2018. This significant growth has made it a competing force in the industry. In 2018 a downtrend was recorded in the international financial system because of currency depreciation in emerging economies, normalization of interest rates in developed countries, escalating trade wars, and volatilities due to Brexit. Despite this global scenario, the Islamic finance industry grew by 6.9%. This growth was assisted by appreciation in oil prices and credit growth leading to better asset quality. The global IFSI has a positive future outlook and is predicted to maintain its positive growth trajectory, supported by market developments in all its main components.

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Introduction to Sustainable Development Goals (SDGs)

2.1

History of the Development of SDGs

The SDGs are a result of decades of work by different countries along with the UN, including the UN Department of Economic and Social Affairs. The following timeline shows the series of efforts and events that took place for the SDGs to be coined in 2015 (Fig. 1). 2.2

Overview and Progress

As shown in Fig. 2, the progress toward achieving SDGs is not enough to meet the targets by 2030, which is now just a decade away. The global pandemic of 2020 has further hampered the progress that has been made thus far. The United Nation’s Secretary-General, António Guterres said “Our efforts to achieve the Sustainable Development Goals will require a surge in financing and investments.” In order to achieve these targets,

Fig. 1 History of the formation of SDGs (Source Adapted from UN Department of Social and Economic Affairs, n.d.)

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Sustainable Development Goal

1.

End poverty in all its form everywhere

2.

3. 4.

5.

6. 7.

8.

9.

10. 11. 12.

End hunger, achieve food security and improved nutrition and promote sustainable agriculture Ensure healthy lives and promote wellbeing for all at all ages Ensure inclusive and equitable quality education and promote lifelong learning opportunities for all Achieve gender equality and empower all women and girls Ensure availability and sustainable management of water and sanitation for all Ensure access to affordable, reliable, sustainable and modern energy for all Promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all Build resilient infrastructure, promote inclusive and sustainable industrialization and foster innovation Reduce inequality within and among countries Make cities inclusive, safe, resilient and sustainable Ensure sustainable consumption and production patterns

13.

Take urgent action to combat climate change and its impacts

14.

Conserve and sustainably use the oceans, seas and marine resources

15.

Sustainably manage forests, combat desertification, halt and reverse land degradation, halt biodiversity loss

16.

Promote just, peaceful and inclusive societies

17.

Revitalize the global partnership for sustainable development

Progress The world is off track to end poverty by 2030. Food insecurity is on the rise. There is progress in many health areas but acceleration in efforts is required. Progress towards inclusive and equitable quality education is too slow. Although there have been improvements, full gender equality remains inaccessible if progress continues at the same pace. Basic water and sanitization services are still inaccessible for millions. Efforts towards sustainable energy need to be scaled up. Global economic growth has been slow.

Industrial and manufacturing growth has been declining. In some countries, income inequality has decreased. The percentage of urban population living in slums is rising. Globally, the use of natural resources is still unsustainable. The world has not been taking serious actions required to reverse the climate crisis. Ocean acidification continues to threaten marine environments and ecosystem services. Global efforts to halt biodiversity loss are not sufficient. Civilians have been getting killed in armed conflicts despite protections under international law. Aid to Africa and Least Developed Countries has been rising but official development assistance has not improved.

Fig. 2 Overview of SDGs and progress toward targets to be achieved by 2030 (Source Adapted from The Sustainable Development Goals Report 2019 [United Nations, The Sustainable Goals Report 2019, 2019a] and [United Nations, About the Sustainable Development Goals, 2020])

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a strong financial foundation is needed to subsidize and fund activities. Considering the size and complexities of the global financial system, availability of financing for sustainable development is not a problem, with gross world product at USD 80 trillion and gross financial assets valued at USD 200 trillion. The conventional financial system has, however, failed to channel the available finance toward the cause of sustainable development fast enough to achieve the intended targets by 2030. Wu Hongbo, Under Secretary General, Economic, and Social Affairs said “Globally capital is plentiful. The financial resources are there. But they must be unlocked, mobilized, channeled and used more effectively for sustainable development ” (Sadiq & Mushtaq, 2015). There is an annual requirement of USD 2.5–3 trillion to achieve SDGs in developing countries (United Nations, United Nations Secratary General’s Roadmap for Financing the 2030 Agenda for Sustainable Development, 2019b). This financing gap creates an opportunity for Islamic finance to mobilize its resources to fund global measures being undertaken toward sustainable developments. This chapter will discuss the role Islamic finance can play to contribute toward expediting actions in this global partnership effort.

3

Financing Sustainable Development

There is an annual requirement of about USD 5–7 trillion to be invested toward the attainment of SDGs. The private sector organizations are working tirelessly toward global sustainable development and they will need to keep up their efforts in order to realize the 2030 Agenda. It can be helpful to establish sustainable financing strategies for investments at national and international levels along with aligning economic and financial policies with SDGs at a broader level. Digitalization of the industry and innovative financial offerings can help provide equitable access to funds (United Nations, United Nations Secratary General’s Roadmap for Financing the 2030 Agenda for Sustainable Development, 2019b). A large network of corporations, investors, insurance providers, and banks are working toward the promotion of SDGs working under the joint of group of UN Global Compact, the UN Environment Finance Initiative (UNEP-FI) and the Principles for Responsible Investment (PRI) (UN Global Compact, n.d.). A collaborative effort by all sectors across the economy to overcome the challenge of mobilizing money to close the financial gap can lead to the successful attainment of targeted outcomes of

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Agenda 2030. Also, there is a need for effective governance and reformations in the structure of public and private sectors and how they interact to enable efficient economic, social, and environmental sustainable development (United Nations Development Programme, n.d.). UNDP encourages countries to make SDGs the core and center of their financial systems. In order to assist countries in doing so, the following strategic areas have been highlighted by UNDP: • Financial Strategies in relation to SDGs and Integrated National Financing Frameworks • Budget reforms to integrate SDGs into domestic public finance • Developing fiscal instruments aligned with SDGs • Allocating private finance for SDGs • Utilizing global public finance • Aligning business operations and strategies with SDGs • Reporting impact measurement for financing SDGs. 3.1

The Economic Aspect of Financing SDGs: A Comparison of Conventional and Islamic Views

Some countries have been continually increasing their efforts and investments in sustainable development. Achieving SDGs is predicted to have a positive economic impact with the opening of USD 12 trillion in new markets value and creation of 380 million employment opportunities with USD 26 trillion in savings due to actions on climate change. As recognition is rising about the economic benefits in sustainable development investment, public budgets are incorporating SDGs and financial systems are adopting more “green” measures. Green bond issuances grew significantly from USD 2.6 billion in 2012 to USD 167.6 billion in 2018. Innovative SDG-related financial instruments are opening up new sources of finance and the potential of technology is being used to maximize mobilization and utilization of capital for SDGs. The statistics for sustainable investments are on the rise, globally. This success and progress come as the financial industry is beginning to acknowledge the benefits of sustainable investments and the importance of evaluating environmental risks when making financial decisions (United Nations, United Nations Secratary General’s Roadmap for Financing the 2030 Agenda for Sustainable Development, 2019b).

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However, in hindsight, estimates show that the share of sustainable investments in global financial assets remains small. There is a lack of standardization in definitions and impact measurements. Investments that are reported to be sustainable could just be representing financial instead of real asset investments. Business practices will have to become even more sustainable in order to avoid falling short of meeting SDG targets. To accelerate the transformation of the private sector toward sustainability, financial systems need to have a long-term approach. Investors have always shown a selfish interest in sustainability issues in the greed for financial returns (Task Force on Financing for Development, 2020). This materialistic approach is tied to the conventional financial system which was developed for a secular society, where common goals and cooperation could not be assumed. It is based on a society of people pursuing individual selfish interests, which may or may not be in harmony. Currently, all conventional private investors are focused on the increase in their wealth and value through production and growth, albeit under the shadow of investing toward sustainable development. These objectives are justified by using the trickle-down effect phenomenon which is said to lead to reduction in poverty and economic misery. However, it has been proven many times that growth does not lead to alleviation of poverty. Rising global wealth has been accompanied by rising poverty levels over the years. Additionally, current levels of wealth are more than sufficient to provide for the planet and its occupants, provided that the distribution of income is done in a fair and equitable manner as prescribed in the Quran and Hadith. The Islamic economic system, from which the financial system stems, urges the feeding of the poor, discourages wastage of food, appreciates good treatment of others and prohibits pursuing idle desires that lead to selfish consumption of wealth. Excess wealth is to be spent on the welfare of society in the form of Zakat, charity, and Waqf. The Quran also offers the powerful tool of Amr bil Maroof wan Nahi Anil Munkir (enjoining good and forbidding evil) as a means of transforming the world to bring these principles into the lives of human beings. These are genuine and practical methods of solving the problems of the earth and its people and achieving the SDGs, as opposed to the Keynesian solution of accumulation of wealth as a solution to all of mankind’s’ problems (Zaman, 2012). (Zaman, 2012) offers a comparative analysis of the neoclassical and Islamic economic framework. Traditional economists believe that selfish behavior has a positive impact on the society as a whole and this natural

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motivator can be used to predict economic behavior. Economic theory makes no value judgments so it has no consideration for wealth distribution. It believes that resources available on earth are not sufficient so there is a need to increase production. Productivity can be increased through industrialization and technology and once enough capital is accumulated, problems of scarcity will be resolved and there will be development. People will be kind and just because they will be free from want. In order to support that development, there should be no restrictions on the operations of markets. Perfect competition will enrich the society because greed and selfishness will lead people to be most efficient. If the capitalists are powerful and rich, there will be rapid development through investments; the benefits of which will trickle down to the poor. Profit maximization is most important even if it comes at a cost of morality and ethics. Firms will only consider immediate actions and they are neither questionable for their intentions nor responsible for the long-term consequences of those actions. The neoclassical framework leads to corrupt and selfish societies with inequality in resources, opportunities, and thus growth. On the other hand, the Islamic outlook on key economic aspects is more plausible. Islamic economists believe that selfishness leads to corruption and people need to be encouraged to be cooperative and generous and not give in to their greedy, acquisitive desires. Redistribution of wealth is mandatory in Islam. It is believed that the world has been bestowed with sufficient resources to meet everyone’s need, provided people do not save beyond their needs. Accumulating wealth will never lead to true contentment. Instead, people need to be morally and spiritual kind and economic growth will follow. In a cooperative and trustworthy society, the rich and powerful will care for the weak building nations that are spiritually, morally, and materially developed. There will be robust growth through economic justice and opportunities for all. The Quran encourages people to spend on their needs but avoid indulging in idle and luxurious desires. Excess money should be spent on those that cannot afford to satisfy their own needs. Morality and ethics transcend the pursuit of profits and everyone is responsible for their intentions and the consequences of their actions. These beliefs and values of the Islamic economic framework, if followed in their true essence, lead to societies that are hospitable and responsible with uniform economic growth.

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A comparative analysis of key economic aspects shows that the Islamic viewpoint is more suitably aligned to the objectives of Sustainable Development Goals. Islam assumes common social goals and commands us to cooperate and love one another to be true believers. Following these commands laid down by Shari’ah will change the world for the better. The next section discusses the similarities in Islamic finance and SDGs and the role Islamic finance is playing to achieve these goals efficiently.

4 4.1

Islamic Finance and SDGs

Linking Islamic Finance Principles to SDGs

In our discussion so far, we have established the fact that in order to help improve progress toward delivering on SDG targets by 2030, there is a need to contemplate new strategies in global partnerships and design innovative sources of finance to leverage private investments. In this regard, Islamic finance has emerged as an effective tool in responding to the financing needs of SDGs. As it is one of the most rapidly developing sectors of the global industry, Islamic finance has untapped potential as a sufficient and ethical source of financial development assistance. Along with the lack of efficient mobilization of funds toward SDGs needs, conventional finance is also problematic because it has diverted from the objectives of sustainable development leading to a lot of economic, social, and environmental problems. The conventional financial system focuses on financial risk and return considerations, without taking into account any negative externalities associated with investment decisions. The strength of Islamic finance lies in it being a more ethical alternative to building a more sustainable future. The Islamic financial system resonates with the goals set out in the 2030 Agenda because of its embedded moral and ethical values and principles. With its diverse social finance tools, it can serve as an important complementary and supplementary means to promote SDGs. Islamic finance has the capability of displaying a crucial part in supporting the accomplishment of Sustainable Development Goals because of the following unique Shari’ah principles (United Nations Economic Commissions for Africa, 2018): • Riba is prohibited and debt is limited to the value of assets to eradicate selfish greed and hoarding.

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• Risks and rewards are shared in various Islamic modes of financing which promotes fair access to assets, goods, markets, and finance for all. • Excessive uncertainty, deception, speculation, and gambling are all forbidden in order to discourage irresponsible behavior. • Asset backing of transactions is compulsory which links the financial system with the real economy. • Investments and transactions with forbidden (haram) industries (e.g., alcohol and related business, weapons, drugs, tobacco, etc.) are prohibited because these are harmful to either individuals or the society at large. • Compulsory and voluntary donation modes (zakat, sadaqah, waqf, and Qard Hasana) that facilitate the fair redistribution of wealth and opportunities promote a sense of solidarity and foster social welfare. The ultimate aim of these principles is to create a sustainable, impartial, and ethically responsible financial system. 4.2

Maqasid e Shari’ah in Relation to SDGs

The Shari’ah is very comprehensive in that it provides a holistic view on all aspects of life including economic and financial principles. With regard to the economic and financial aspect, it covers not only the legal and moral principles of contracts but also theories of economic behavior which define the activities of individuals and markets. To make the natural market forces operate in an equitable manner, it is vital to control them so that there is equal distribution of wealth throughout the economy to accommodate the needs of all fairly. Greed for wealth makes a person unable to differentiate between right and wrong so there should be rules to govern our greedy actions. Money has no intrinsic value and it is the means to achieve a certain objective. Therefore, whoever hoards money or carries out transactions on interest, is committing injustice. Money is not a commodity in itself so trading of money for money, all forms of interest, short selling, sale of debts, speculation, and derivative transactions are not allowed in Islam. These activities provide people with a risky but easy way of earning money without any participation in real economic activities. People are encouraged to undertake real economic transactions by using their savings to generate income

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and giving them a proportionate share in the profits and losses generated. Asset backing of debts ensure there is no mismatch between the real economy and capital. Furthermore, all transactions must be transparent to a level where they are understood by all stakeholders involved (Usmani, 2010). While economic transactions are promoted as they preserve and support wealth and prosperity, all economic and financial activities must also support the Maqasid e Shari’ah. The objective of Islamic rulings is mainly to preserve these five elements from any harm. These are: • • • • •

Protection Protection Protection Protection Protection

of of of of of

Faith or religion (din) Life (nafs) Progeny (nasl) Intellect (‘aql) Material Wealth (mal).

Islamic law aims to promote welfare (maslahah) and prevent harm (mafsadah). From a macroeconomic perspective, this means that an economy should work toward eradicating income inequality through equitable growth and stability among all sections of the population. From an individual perspective (micro maqasid) this implies that firms should avoid activities that harm the society (e.g., selling harmful products, dumping toxic waste in the environment, speculative ventures), and abide by the rules laid down for contracts (e.g., transactions must be linked to real activity, sales lead to transfer of property rights, selling debt is not allowed, etc.). In Shari’ah, there are two key legal maxims that govern economic and financial transactions. The first is the legal maxim Al Ghurm bil Ghunm, one is entitled to gain only if one agrees to bear the responsibility for the loss. This maxim promotes the use of profit and loss-sharing instruments like Musharakah and Mudarabah. The second legal maxim is Al Kharaj bil Daman, one can claim profit only if one is ready to take liability. This maxim implies that those benefiting from the asset should also bear the associated ownership risks (Ahmed et al., 2015). Figure 3 highlights the links between the 17 SDGs and 5 Maqasid e Shari’ah.

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Fig. 3 Links between SDGs and Maqasid e Shari’ah

4.3

The Role of Islamic Finance in Sustainable Developments

(Sadiq & Mushtaq, 2015) defined sustainable development as “a concept that combines meeting the needs of the present without compromising the ability of the future generations to meet their needs.” The achieving of SDGs depends on three main factors: economic growth, social inclusion, and environmental protection. Islamic finance plays an important role in these aspects. It is necessary to understand how the Islamic financial system is and can continue to contribute to achieving sustainable development. The five key areas in which the role of IFIs can be discussed are: increasing financial sector stability and resilience, enhancing financial inclusion, reducing vulnerability and mitigating risk, resolving social and environmental problems and facilitating infrastructure development. Increasing Financial Sector Stability and Resilience One precursor to achieving economic growth is a robust and resilient financial sector. The financial crisis of 2008 showed that excessive debt, mortgage-backed securities, credit default swaps and collateralized debt obligations, speculation and derivatives, among other factors, led to the instability of the financial sector through high-risk exposure. In light of

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this, the Islamic financial sector has the potential to bring more stability to the financial system due to its principles of risk-sharing and asset-backed financing, which prevents a mismatch between the real economy and financial transactions. However, because IFIs are operating in a predominantly conventional system, they face many limitations in putting the ideal concepts of participation in risks and rewards into practice. The liabilities side is more based on risk and reward sharing but the assets are mostly debt-based financing. In order to compete with conventional sector, they often resort to less preferable instruments. There is a need to switch over from the current debt-based financial set up to a system of banking based on equity (Usmani, 2010). Equity-based financing will help diminish systemic risks, decrease the probability of insolvencies and make the overall financial system more stable. Modarabas in Pakistan established according to the Modaraba Companies Ordinance of 1980 follow the ideal risk-sharing equity-based financing principles. Crowdfunding, private equity and venture capital firms and investment banks are other options in which the Islamic finance sector needs to evolve to be able to better stabilize the financial system required for economic growth. There is a need for more awareness among finance professionals about the various business and financial risks involved when dealing with equity financing e.g., strong monitoring, counter-party risk, etc. (Sadiq & Mushtaq, 2015). Furthermore, increasing the share of Islamic finance in stock markets and sukuk would expand its role in equity-based capital markets. Shari’ah compliant stock market assets make up a very small percentage of the overall assets. By establishing relevant institutions and strengthening legal and regulatory frameworks, Islamic finance can prompt the listing of more valuable companies which will increase the share of Islamic equity in the financial sector. Using of equity-based sukuk such as those based on Musharakah or Mudarabah should be promoted. The public sector can play its role in this aspect by employing risk-sharing capital market instruments (e.g., GDPlinked sukuk) for finance developmental projects (Ahmed et al., 2015). Enhancing Financial Inclusion Without equitable allocation of finance, sustainable development goals cannot be met. Muslim countries are ranked among the poorest nations of the world. In order to alleviate poverty, which is the first SDG, it is necessary that financial services are available to the poor. According to

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research, about 72% of the Muslim world does not use any formal financial services; around 20–40% avoid using these microfinance services because of interest. Lenders find it costly or risky to provide loans to the poor. The low percentage of financial inclusion can be attributed to a variety of economic, social, and religious reasons. These demographics create a gap that can be filled by Islamic microfinance services. Islamic microfinance institutions are the key to establishing sustainable avenues for inclusive finance. While helping to eradicate poverty and achieve sustainable development, Islamic microfinance institutions can help IFIs establish the social role that the Shari’ah advocates. For maximum financial inclusion, these institutions must reach out to various segments of the economy to provide finance. In comparison to conventional financial institutions, IFIs are playing a more significant role in microfinance which is made possible by a widespread network of bank branches supported by existing operations allowing for efficient transactions with a large number of clients. Other entities like NGOs, cooperatives, credit unions and mutual insurance companies can contribute to enhancing financial inclusion by offering a wide variety of services including savings, financing, financial planning, banking, etc. The central bank can form and enforce policies that ensure provision of financial services to different sections of the economy. Aligning the social sector with IFIs by using Waqf and Zakat to enhance the productive capacities of the poor can lend to the very nature of social impact that the Shari’ah principles stress upon. These can be used to subsidize the cost of providing financial services to the poor or to support entities in expanding their network. In this way, charitable funds can partially solve the problems of sustainability and outreach. Waqf-based Islamic financial institutions can also be established to alleviate poverty by providing interest-free loans funded by Waqf capital (Ahmed et al., 2015). Reducing Vulnerability and Mitigating Risk Various researches have proven the existence of a relationship between risk and poverty. Better risk management in a society means that the poor are less vulnerable to risk events. Since negative shocks can lead to an increase in the number of poor, a resilient social system is crucial for sustainable development. Because Islamic financial system focuses on risk-sharing rather than risk-transferring, it can be used to reduce vulnerability through its unique

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risk-mitigating mechanisms. Takaful (Islamic insurance) based on charitable donations or mutual help can be provided to different segments of the population, including the poor. There is a lot of potential for growth in Takaful in the upcoming years. Commercial and non-profit entities can contribute to the resilience of the financial system by providing services to participants either directly or through agents and intermediaries. Charitable funds can also be used in this regard to pay the monthly takaful contributions (premiums) to hedge against some defined risks or provide interest-free loans to the deserving. This will not only increase penetration of Takaful among the poor but also reduce the vulnerability of the poor by acting as a safety net. Resolving Social and Environmental Problems Studies show that the Islamic financial institutions are ignoring environmental and social goals. One of the reasons for the lack of concern of Islamic banks is because in practice, the concepts of environmental and social sustainability have not been fully integrated with Maqasid and Shari’ah compliance. To enhance the contribution of IFIs to environmental and social goals, there is a need to expand Maqasid to include these broader perspectives at the operational level. The concept of Shari’ahbased financing will have to be modified to include environmental and social goals as necessary factors of macro-maqasid. In order to persuade the industry players to recognize these problems as crucial to Islamic banking operations, an authoritative Shari’ah body like the Islamic Fiqh Academy affiliated by OIC will have to acknowledge environmental and social issues as important elements of maqasid al-Shari’ah. Changes will have to be made on all fronts of the Islamic financial industry. Investment screening criteria for the stock market must also include factors related to ESG goals and socially sound values and practices. It is the responsibility of the Board of Directors to ensure the ESG issues are aligned with the mission and goals of their respective IFIs. The organizational norms and values must adopt the broader sense of the Maqasid. IFIs can also contribute indirectly by investing in the social sector thus increasing the capacity to produce social goods. To promote responsible investing, various funds dealing with social issues like venture philanthropy and environmental issues like climate change can be launched. Promoting issuing of socially responsible and ethical sukuk for various social and environmental causes can be an important contribution. Furthermore, by improving the efficiency and

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effectiveness of Zakat institutions in collection and disbursement and reforming the Waqf sector, the Islamic finance sector can help resolve environmental and social issues (Ahmed et al., 2015). Facilitating Infrastructure Development Infrastructure development is not only important for efficient commerce and trade but it also enhances competition and leads to long-term growth. Sustainable infrastructure development would require the process and results to be environmentally friendly and have a positive societal impact. Traditionally, governments have provided infrastructure facilities but in many countries they lack resources for this responsibility due to large deficit and debt amounts. High requirements for infrastructure investment funds point toward the need to find innovative ways in which new players can contribute to the development of sustainable infrastructure. This is an ideal business opportunity for Islamic finance because financing such projects would contribute to the welfare of the society at large. Public, private, and retail sukuk are being used to fund infrastructure projects. Shari’ah compliant syndicated financing is another avenue which is gradually gaining popularity to fund infrastructure projects through a diversity of sources. Figure 4 summarizes the role of these factors in affecting different SDGs. 4.4

Resource Mobilization Modes for Sustainable Development

Islamic finance offers a variety of instruments and modes that can be used to assist its role in sustainable development. Besides the traditional philanthropic tools of Zakat (compulsory almsgiving), sadaqah (charity), and Waqf (endowments), other asset-based structures that support longterm investments include Mudarabah and Musharakah (partnership based on loss and profit sharing), Murabaha (cost plus profit financing), Ijarah (leasing), Salam, Istisna, Islamic microfinance, and Sukuk (Islamic bonds). Islamic microfinance, Zakat, Sadaqah, and Waqf have a central role to play in the pursuit of many SDGs. Poor people can also contribute to economic growth if they are endowed with an enabling environment. These modes ensure that economic empowerment through an integrated approach. Zakat is one of the pillars of Islam which requires Muslims owning a certain threshold level of wealth to annually distribute a percentage of their income among the deserving. Sadaqah is a voluntary

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Fig. 4 Linking the role of Islamic finance to SDGs (Source Adapted from Ahmed et al., 2015)

act of giving charity to help those in need and is highly encouraged by Shari’ah. Waqf is charitable endowments that can have important positive social and economic implications. Waqf can be endowments in the form of immovable assets or even provision of economic relief. These modes can be used as effective distributive schemes in taking care of the poorer sections of the population in Muslim societies, provided efficient collection, distribution, and allocation. 4.5

Global Examples

• Shekra was the Islamic crowd-funding platform launched in 2013 in Egypt. It allowed people to collectively invest in enterprises. The same model can be adopted by other countries which have the required regulatory framework, technology, and social media access. • Islami Bank Bangladesh Limited started the Rural Development Scheme which is a microfinance program that provides microfinance more efficiently than existing microfinance institutions.

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• In Malaysia, Bank Kerjasama Rakyat is a cooperative bank that has a program for microfinance called the ArRahnu program. It offers microfinance services through its branches and center. The bank also offers a wide variety of other services including consumer financing, commercial financing, financial planning, electronic banking, and financing to SMEs. • In 2014, the Indonesian government issued a retail sukuk worth USD 1.7 billion to finance infrastructure development projects. This instrument, which is the largest ever Islamic instrument issued in the country, was well-received and oversubscribed by investors from a wide variety of backgrounds including self-employed, housewives, private sector employees, civil servants, and army officers. • In 2017, the central bank of Malaysia, Bank Negara Malaysia launched the first-ever green sukuk with the support of World Bank Group and Global Knowledge Research Hub. The capital raised through this sukuk will be used to finance infrastructure development projects that have a positive impact on the environment e.g., construction of facilities for renewable energy generation.

5

Future Outlook

Islamic finance principles support socially inclusive, environmentally sustainable, and development promoting activities. However, practically the Islamic finance industry has a long a way to go to live up to its potential of contributing to these objectives. In order to improve its role, a few challenges being faced by the industry will need to be overcome. There is a need to progress from the Shari’ah compliant system to one which is Shari’ah based that innovates and creates products to fulfill the real needs of the economy. Re-modeling products, services, practices, and operations to a more sustainable business model will allow greater sustainability. Innovative and customized financial services offerings will provide a more holistic experience to all customers alike. There is a need to embrace Fintech to revolutionize the industry. This new technology can be used to enhance financial inclusion and assist in efficient collection and distribution of funds. Standardization of legal and regulatory frameworks and guidelines across the industry will help form global partnerships more easily by creating harmonization

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across regions. In order the foster the foundations for sustainable development by Islamic finance capacity building is necessary to support a more enabling environment. This requires acquiring quality talent with a passion to build a more sustainable business model and enhancing skills, awareness and knowledge of staff to effectively provide and implement solutions to real world problems. Most importantly, there is an urgent need to integrate sustainability into the decision-making process of any project by including the considerations of social and environmental dimensions unlike the current practice of exclusively assessing economic aspects.

References Ahmed, H., Mohieldin, M., Verbeek, J., & Abdul Magd, F. (2015). On the sustainable development goals and the role of Islamic finance. World Bank Group. ICD-Refinitiv. (2019). Islamic finance development report 2019 shifting dynamics. Islamic Corporation for the Development of the Private Sector. IFSB. (2016). Islamic financial services industry stability report. Islamic Financial Services Board. IFSB. (2019). Islamic financial services industry stability report. IFSB. Research and Markets. (2019). Global Islamic finance market—Growth, trends, and forecast (2018–2024). GlobeNewswire. Saba, I. (2018). Comparative Shariah governance framework in selected Muslim countries. Journal of Islamic Thought and Civilization, December, 337–373. Sadiq, R., & Mushtaq, A. (2015). The role of Islamic finance in sustainable development. Journal of Islamic Thought and Civilization, 5(1), 43–55. Siddiqui, A. A. (2013). Islamic banking industry growing amid challenges. Journal of Islamic Banking and Finance, 30, 13–18. Task Force on Financing for Development. (2020). Financing for sustainable development report 2020. United Nations. UN Department of Social and Economic Affairs. (n.d.). The 17 goals. https:// sdgs.un.org/goals. UN Global Compact. (n.d.). UN alliance for SDG finance. Accessed June 2020. https://www.unglobalcompact.org/take-action/action/globalalliancef orsdgfinance. United Nations. (2019a). The sustainable goals report 2019. United Nations. United Nations. (2019b). United Nations secratary general’s roadmap for financing the 2030 agenda for sustainable development. UN.

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United Nations. (2020). About the sustainable development goals. Accessed June 2020. https://www.un.org/sustainabledevelopment/sustainable-develo pment-goals/. United Nations Development Programme. (n.d.). Finance and private sector engagement for the SDGs. Accessed June 2020. https://www.undp.org/con tent/undp/en/home/2030-agenda-for-sustainable-development/partnersh ips/sdg-finance--private-sector.html. United Nations Economic Commissions for Africa. (2018, June). Islamic finance: Innovative financing for the SDGs. Accessed June 2020. https:// www.uneca.org/sites/default/files/uploaded-documents/HLPD/2018/if_ and_sdgs-shsh-june21-2018-single.pdf. Usmani, I. A. (2015). Guide to Islamic banking. Maktaba Ma’ariful Quran. Usmani, M. T. (2010). Post-crisis reforms some points to ponder. Zaman, A. (2012). An Islamic critique of neoclassical economics. Pakistan Business Review, 14(1), 9–62.

CHAPTER 5

Islamic Finance: A Literature Review M. Kabir Hassan, Ashraf Khan, and Andrea Paltrinieri

1

Introduction

The fundamentals of Islamic Finance are deeply rooted in the Islamic civilization and originated from Islamic jurisprudence and laws. Islamic finance differentiates itself from conventional finance on the basis of four main underpinning principles i.e., (1) Islamic finance does not allow any transaction that involves interest, thus tradability of debt is also prohibited (Alshater et al., 2020), (2) prohibition of Uncertainty (Gharer), (3) Transaction involving gambling and speculation are not allowed, (4)

M. K. Hassan (B) Department of Economics and Finance, University of New Orleans, New Orleans, LA, USA e-mail: [email protected] A. Khan Institute of Business Administration (IBA), Karachi, Pakistan e-mail: [email protected] A. Paltrinieri Department of Economics and Business Administration, Università Cattolica del Sacro Cuore, Milan, Italy e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8_5

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Non-shariah business activities such as liquor business (Hassan & Aliyu, 2018) The aforementioned principles mitigate ambiguity, moral hazard, and adverse selection in financial contracts for all stakeholders and further ensure transparency in the financial system. Over the last decade, Islamic finance has showcased a tremendous growth with total assets of over USD 2438.6 billion (IFSB, 2020) and primarily comprises Islamic banking, Takaful, and Islamic fund market (both sukuk and islamic stock market). After the global financial crises, it has emerged as an alternative system of conducting financial affairs based on mutual risk-sharing with lower level of systemic risk to mitigate social inequalities and uplift the unprivileged segment of society. Islamic finance is largely driven by the belief within the theme of Islamic economic theory to eliminate social injustice and provide solutions to socio-economic challenges faced by the societies. The implementation of the Sustainable Development Goals (SDGs), as well as socially responsible investment, raises the prospects for Islamic finance to expand its global share in the financial spectrum (Hassan & Aliyu, 2018). Nevertheless, Islamic finance is also subject to face challenges. The biggest obstacle, faced by the Islamic finance industry, is to integrate financial technologies, including all clients, standardize Shariah analysis and legal documents. Islamic finance is claimed to be in line with responsible finance and value-based finance, which can contribute to environmental, social, and governance (ESG) factors. Being consistent with growth of Islamic finance, there is large amount of literature discussing the performance of Islamic financial institutions, Islamic money and capital markets and takaful. Therefore, the main aim of this chapter is to synthesize the literature in the broader context of Islamic finance; encompassing both theoretical and empirical studies to understand the alignment of practices of Islamic finance with its theoretical features. Following the previous literature (Hassan et al., 2019a), we content analyzed 92 articles published in important mainstream journals indexed both in Scopus and Web of Science (WOS).

2

Review of the Literature

Adejoke et al. (2013) examine the predictability of short- and long-term profit rates of Malaysian Sukuks over the period between 2001 and 2010. Specifically, their study investigates whether future spot profit rates can be accurately predicted by the long-term profit rates of the Malaysian

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Islamic bonds. Their results suggest that long-term profit rates are not strong predictors of future spot profit rates. Their findings contradict the Expectation Hypothesis but support the Liquidity Preference Theory as well as the Market Segmentation Theory. Ahmad and Hassan (2006) study the concept of time value of money (TVM) from the perspective of Islamic finance and examine whether TVM is permitted by Shari’ah principles. They argue that TVM is not forbidden as long as it’s not claimed as a predetermined value in a lending contract. According to Shari’ah rule, a loan must be due in its original or issuing currency. In their study, Ahmad and Hassan (2006) attempt to investigate the time valuation methodology used in Islamic finance and whether any value might be attributed to time while considering the value of money. Other relevant issues such as juristic views on acceptability of different commodity prices based on cash/credit and increase or decrease in loan amount in case of early repayment have also been taken into consideration. Based on a novel dataset on sukuks, Ahmed et al. (2018) investigate when and why firms issue sukuk and whether investors conceptualize and value sukuk differently from a conventional bond. The document that abnormal returns are significantly negative around the issuance of a sukuk. Using OLS as well as logistic regressions, they examine the effects of financial characteristics of issuers on the likelihood of sukuk issuance as well as on the abnormal returns around the issuance. They report that small (large) and more (less) risky firms have a greater (smaller) likelihood of issuing sukuk and are subject to more (less) negative abnormal returns around the issuance of their sukuks. AlAbbad et al. (2019) study the influence of Shari’ah boards’ characteristics on the risk-taking behavior of Islamic banks. As argued by Jensen (1993) and Pathan (2009), board characteristics play a vital role in bank risk-taking, however, the impact of Shari’ah board’s characteristics on the risk-taking behavior of Islamic banks has still been an empirical issue. In general, Islamic banks under Shari’ah rules are supposed to be less exposed to risky initiatives. Consistent with prior literature, the findings of AlAbbad et al. (2019) suggest that the size and busyness of the Shari’ah Supervisory Board (SSB) are positively associated with the risk-taking behavior of the Islamic bank. Their findings are more profound for Gulf countries where Shari’ah principles are at the core of bank governance. In a natural experiment, Alalmai et al. (2018) re-examine the determinants of capital structure in Saudi Arabia. Specifically, their study

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investigates the influence of religion on corporate capital structure of Saudi Arabian firms. Applying extreme bound analysis (EBA) on a dataset of Saudi Arabian firms with highly religious (Islamic) environment, their results indicate that firms having Islamic environments are subject to less leverage as opposed to firms without such environment. However, this finding does not hold for growth firms with strong religious environment. Studying an international dataset of 79 sukuks and 87 traditional bonds from six different countries over the period between 2004 and 2012, Alam et al. (2013) examine the difference between Islamic and conventional bonds, especially around the financial crises. Their empirical results indicate that market reaction was negative (positive) for the announcement of sukuk (conventional bond) before and during the 2007–2008 crisis. They also argue that the bond offer size is negatively associated with the cumulative abnormal returns around the sukuk announcement. Using a hypothetical investor following Islamic Investment Guidelines in the US capital market, Alhenawi and Hassan (2013) investigate the influence of Shari’ah compliance on the US REIT market. Based on a sample of Shari’ah-compliant REIT’s during the period from 1990 to 2010, their results reveal that Shari’ah compliance leads to outperformance during the entire sample period. Risk-adjusted tests produce similar results during the times of economic downturn. However, multivariate analyses suggest that there is no significant difference between performances of compliant and non-compliant portfolios. The authors conclude that conservative approach toward debt, interest, and cash may lead to the outperformance of the compliant portfolio. Alhomaidi et al. (2019) empirically examine the impact of religious certification on market segmentation and investor recognition. Specifically, they conducted a comparative analysis of performance between conventional and Islamic stocks/assets in Saudi capital market to test the effects on market segmentation and investor recognition. Using an extensive sample of the daily stock returns of all Saudi firms over the period 2002–2015, they find evidence that Islamic stocks are more sensitive in response to changes in macroeconomic variables, supporting the market segmentation hypothesis. They also report that Islamic stocks exhibit greater liquidity, lower exogenous risk, and higher systematic turnover, supporting the investor recognition hypothesis. Alhomaidi et al. (2018) investigate stock price co-movements and commonality in liquidity in the case of Islamic stocks. They hypothesize that stock classification based on Shari’ah compliance affect the trading

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and investment decisions of individual investors who are not financially literate. The paper finds evidence in favor of stock price co-movements and commonality in liquidity in the case of Islamic stocks that are classified based on Shari’ah compliance. Considering an Islamic perspective of financial engineering, AlSuwailem and Hassan (2012) study the relevance and significance of financial engineering for the Islamic financial institutions and how Shari’ah compliance may affect the product design and profitability of Islamic financial institutions. The authors suggest that compliance to Shari’ah principles/rules leads Islamic banks and financial institutions to forgo numerous financial products and services that could otherwise generate significant profits for these firms. Azmat et al. (2020) study the relationship between state-contingent banking and asset price bubbles in Islamic banking industry. Their results suggest that the returns for the borrowers, lenders, and the bank are more aligned with the real economy in state-contingent banking, minimizing excessive borrowing, lending, and investing. They also argue that depositors’ payoff would be more volatile in the presence of state-contingent banking during the periods of greater macroeconomic risks, which leads to reduced liquidity influx from the real economy to the banking sector. Furthermore, the authors conclude that state-contingent contracts, by reducing managerial discretion overdetermination of interest rates, may help Islamic banks to avoid too much or too little lending. Bekri et al. (2017) study the dependence structure of six Islamic/Shari’ah-compliant stocks. Use of appropriate models of investment and risk management, which comply to Shari’ah principles/rules, is one of the greatest challenges in modern-day Islamic finance. This paper shows that the employment of the suggested copulas achieves a great amelioration of the modeling of the dependence structure in Islamic finance industry. BinMahfouz and Hassan (2012) conduct a comparative analysis of investment characteristics between conventional and Islamic mutual funds in Saudi Arabia. Their results find no evidence in favor of the association between Shari’ah screening process and absolute or risk-adjusted performance of Islamic mutual funds in Saudi Arabia. According to the systematic risk analysis, Islamic equity mutual funds exhibit reduced market risk, as opposed to their conventional counterparts. Prior studies focused on comparative analysis between investment characteristics of traditional and SRI portfolios. However, existing literature

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fails to investigate the effects of sustainability criteria on the conventional Shari’ah screening process. Bin Mahfouz and Hassan (2013) examine the impact of incorporating sustainable/SRI criteria in the conventional Shari’ah screening process and find significant results. Moreover, they compare the investment characteristics of Shari’ah investment portfolios to conventional sustainability investment portfolios, in order to provide empirical evidence as to whether applying different ethical screening criteria influences the investment characteristics differently. Castro et al. (2020) examine the relative performance of religious and ethical investment funds. Basically, they investigate whether Christian mutual funds are the same as the SRIs. Qualitative evidence suggest that SRI funds put much less emphasis on moral issues as compared to Christian mutual funds. SRI funds perform better than Christian mutual funds. The paper uses traditional and classical methods to compare the performance in order to test the efficiency of the models. Chuweni et al. (2017) empirically examine the degree and efficiency of alternative financial institutions i.e., Islamic REITs in Malaysia. Existing literature suggest that Islamic REITs are subject to greater return, compared to their conventional counterparts. However, the impact of Shari’ah compliance on efficiency levels is yet to be studied. Based on a novel dataset of Malaysian REITs during 2007–2015, the authors find that these REITs can reduce the consumption of inputs by around 36%, suggesting a tremendous potential for improvement. Shariah-compliance has a positive impact. Appropriate capitalization, good governance, and regional diversification are key to increase efficiency. Using asset pricing models, Dharani et al. (2019) examine the performance of traditional and Shariah-compliant stock portfolios in India over the period between 2001 and 2017. They examine the impact of Shariah investment principles on the stock returns’ cross-section. Their findings suggest a positive Shariah effect on stock returns in India. They also document that Shariah portfolios exhibit lower risk as opposed to their conventional counterparts. Overall, the paper concludes that both Islamic and conventional portfolios have similar performance, except that fact that the Shariah portfolio has a lower level of risk. El-Din and Hassan (2007) study the relationship between Islam and speculation in the stock exchange. Stock market speculation is generally prohibited in Islamic finance. Normative Islamic Stock Exchange (NISE), a purely equity-based market, is beyond interest rate financing and is cushioned against “gharar.” According to Tag El-Din (1996) and Kia (2001),

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growing speculative activities create inefficiency in the stock markets, and an optimal level of speculation is therefore required for liquidity and overall efficiency of the stock market. As suggested by Tag El-Din, each publicly traded company shall hire professional portfolio managers being able to determine the fundamental value of company’s stock on a daily basis and using the fundamental value as a benchmark the investors will determine the equilibrium prices in exchange. As suggested by Kia, the government policy should ensure the financial literacy of the investors through effective training. Furthermore, he advised to charge a tax on short-term stock trading activities. Elfakhani et al. (2007) assess the Islamic mutual funds’ performance, risk, and rewards for investing in the Islamic mutual funds. Shari’a scholars in the early 1990s showed the path to mutual funds in compliance with Islamic Law’s ethical guidelines. Since then, the mutual funds grew exceptionally. Besides complying with Islamic Law’s ethical guidelines, the funds also respond to the specific need for more liquid investment tools. Further, the funds’ benchmarking has been a turning point for the industry, giving both Islamic and conventional investors required comparability. The Dow Jones now has more than 50 Islamic indices allowing the tracking of industries’ compliance with Islamic laws easier (Hussein & Omran, 2005). Despite exceptional growth in the Islamic mutual funds, research concerning these funds’ performance and how they fare compared to conventional funds remain scant. Elnahas et al. (2017a) study the effect of religion on corporate decision making and financial reporting. Conventional financial statement analyses disrupt numerous guidelines of Islamic Shariah. They argue that some aspects of liquidity ratios such as undervaluation, uncertainty, and interest-bearing elements are strictly prohibited in Islamic law. Elnahas et al. (2017a) suggest a Shariah-compliant corporate liquidity measure within the traditional corporate bankruptcy prediction framework. They find that the proposed liquidity measure significantly improves Altman’s (1968) Z-score and Ohlson (1980). Elnahas et al. (2017b) investigate agency problems of earnout agreements from an Islamic sharia compliance perspective. Contingent payment clause in M&A deals contradicts Islamic sharia, causing severe agency issues such as long-term value-destroying by the managers during the earnout period. Their findings show that target firms managers manage earnings upward and discretionary expenses downward during the earnout period. A matched sample analysis of non-earnout M&As

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shows significantly lower long-term abnormal returns. Elnahas et al. (2017b) propose a sharia-appealing earnout agreement to mitigate agency problems and increase Islamic sharia compliance in earnout contracts. Erragragui et al. (2018) study the resilience of Islamic and socially responsible indexes among five developed and three emerging markets following the 2008 crisis period. Their approach includes using the multivariate CAPM-EGARCH model to accounts for sudden changes in volatility on daily data over the sample period 2008–2014 model time-varying volatility and ensures reliable estimates. Findings suggest that Islamic indexes were less affected by systematic risk than their SRI counterparts for the sample period. Unlike the Islamic indexes, SRI indexes were more resistant in very integrated markets. They conclude that incentive varies for style investing during Regime-switching. Girard and Hassan (2008) study Islamic and non-Islamic indexes’ performance from 1999 to 2006 and find no apparent performance differences. Unlike the Islamic indexes, conventional indices are relatively more value, and mid-cap focused. This result persists even after controlling for a robustness set of controls. The difference in Islamic indices’ performance vs. conventional index is attributed to style differences between the two types. The multivariate co-integration finds evidence of integration between the two types over the sample period. Girard and Hassan (2008) conclude that risk-reward and diversification benefits are similar for Islamic and non-Islamic indexes. The USA’s Islamic finance industry primarily focuses on expanding retail financial products, whereas institutional investors’ wholesale investment remained underdeveloped. To avoid non-Shariah-compliant investments, expansion of the USA’s wholesale market using the Middle East fund remains under the sensor with individual deals structured. US-based companies entered the Sukuk market to capitalize on financial opportunities rather than religiosity. In their book, Hassan and Mahlknecht (2011) study the Islamic finance industry’s growth and provide Islamic finance guidelines to expand both retail and wholesale Shariah-compliant financial products in the US. Islamic finance’s role in the global financial system has been growing fast over the last few decades. Grassa and Hassan (2015) find that Islamic finance’s significance has gained momentum during the 2008–2009 global financial crisis. However, Islamic finance has not been expanded in France—the European country with the largest Muslim population.

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Grassa and Hassan (2015) explore Islamic finance potentials in France, considering the existing challenges and possible remedies. Grira et al. (2016) assess the economic impact of deposit insurance’s implicit cost for Islamic and conventional banking systems. Using a large sample from 213 countries over the 1999–2013 period, they find that Islamic banks’ deposit insurance premiums are lower than those for traditional banks -not even during the 2008–2009 financial crisis. The result suggests that that conventional banks are riskier than their Islamic counterparts. Interestingly, privately held banks’ deposit insurance premiums are significantly higher than the publicly listed banks. These findings are associated with bank size effects. Grira et al. (2016) conclude that Islamic banks are less exposed to systemic risk than the conventional banking system. Grira et al. (2019) assess the ex-ante cost of equity financing for Islamic public banks and conventional public banks in 68 countries from 1999 to 2012. They find that Islamic banks have a higher equity premium than traditional banks. Interestingly, the documented equity premium is nonmonotonic and varies across countries, and can be partially explained by country-level characteristics. They find that certain country-level elements in improving the cost of equity are more pronounced for the Islamic banking system. Their findings are robust to a battery of endogeneity tests and additional controls. Halim et al. (2019) examine whether the Shariah advisors’ reputation and lead arrangers certification reduce the bond spread. They use a sample of 3355 Islamic bond tranches issued in Malaysia and find evidence in favor of their argument. This certification effect is more significant for impervious issuers. Their findings are robust to a battery of endogeneity tests and additional controls. Hassan et al. (2020) study the basic principles of Islamic economics and finance in their upcoming books, enabling the readers to understand the structures and operations of Islamic banking, Islamic capital market investments, risk management, and accounting for Islamic banking contracts. The proposed textbook will blend theory with a practice focusing on the following objectives: 1. To get an overview of the principles of Islamic economics and understand their contrast with mainstream economics. 2. To get an overview of the basic rules of commercial law in Islamic jurisprudence.

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3. To get an overview of Islamic banking’s basic principles, structures, and operations both in the liability side and asset side operations. 4. To understand Islamic capital market instruments and investment management, including some unique activities peculiar to Islamic investments, such as stock screening and income purification. 5. To understand the different Takaful structures, which are applied for risk management by individuals and corporates. Hassan et al. (2017) study the constraint investment strategies (e.g., Islamic Mutual Funds and Socially Responsible Mutual Funds) that cause losses due to a limited portfolio allocation and focuses on the relative performance of those funds using data from 11 Islamic markets and the USA. Hassan et al. (2017) find that an unconditional co-skewness measure improves asset pricing tests by expanding the mean–variance frontier specification. They find that Islamic mutual funds outperform Socially Responsible Investing, which surpasses conventional mutual funds. Hassan and Girard (2010) examine the performance of seven Dow Jones Islamic Market Index (DJIM) index vs. a matched non-Islamic counterparts using different financial analytic tools, Carhart’s (1997) four-factor pricing models, and co-integration for the period 1996–2005. The authors find no difference between Islamic and non-Islamic indexes for the whole sample period, but performance differences are observed for the sub-sample period. For example, Islamic indexes outperform counterparts from 1996–2000 and underperform them from 2001–2005. They conclude that incentive varies for style investing during Regime-switching. Islamic Finance has experienced rapid growth in recent years in terms of innovation and sophistication, and investment products. Hassan and Mahlknecht (2011) find that Islamic Finance products are less correlated with conventional products and, thus, beneficial alternative investments for portfolio diversification. The book is separated into four parts: General concepts and legal issues, Global Islamic capital market trends, National and regional experiences, Learning from Islamic finance after the global financial crisis. Hassan et al. (2012) study whether Islamic investors are subject to portfolio inefficiency caused by a limited asset universe. Consistent with existing literature, they find that Islamic funds are highly efficient and outperform their international counterparts despite limited diversification

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benefits. Their findings are robust to a battery of endogeneity tests and additional controls. Using the GARCH-M(1,1) model, conditional ICAPM for equity return, and lead-lag relationships among these equity markets, Hassan (2005) explores equity return volatility, predictability, and dynamic linkages of OIC stock markets. The GARCH-M(1,1) model suggests that country-specific elements exert permanent influences on equity market return volatility across the countries. The conditional ICAPM outpaces the unconditional ICAPM in forecasting the equity market return of OIC stock markets. OIC stock markets demonstrate a low-correlation, implying OIC stock markets an ideal portfolio diversification. Islamic economics and finance (IEF) has been evolved into a fully fledged academic discipline in higher education. In this book, Hassan (2016) discusses empirical research on Islamic economics and finance and provides an in-depth analysis of Islamic financial institutions’ performance and Islamic financial products. Islamic scholars’ contribution highlights a socio-economic profile of Muslim countries, an outline of Islamic systems of accounting and governance, and analysis of the religion–development link, a consideration of the role of the state under Islam. Unlike Western entrepreneurs, Muslim entrepreneurs can’t undertake certain economic and financing activities, such as gambling, usury, and speculation, due to the restrictions imposed by Shariah law. Hassan and Hippler (2014) find differences in entrepreneurial outcomes between Western and Islamic economies associated with these restrictions. Simultaneously, the authors remain cautious in comparing the two systems solely based on financial benchmarking. Shariah law argues that the implicit benefits of imposing restrictions on specific business practices outweigh the apparent gains. The authors imply that it is crucial to understand the differences between Western and Islamic entrepreneurs in evaluating these two groups’ relative performance. Hassan and Kayed (2009) showed that Islamic firms are more efficient and equitable in distribution of income and wealth, compared to their counterparties, as Islamic firms adopt profit-and-loss (PLS) sharing principle. Under PLS sharing, allocation of funds is based on the feasibility and profitability of the proposed entrepreneurial undertakings rather than creditworthiness of competing entrepreneurs. Furthermore, PLS incentivizes both sides (entrepreneurs and investors) to be engaged in the productive economic activities, as entrepreneurs are motivated by seeing

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their ideas transformed into realities, and financers will be more involved in assessing the risk, and hence effectively monitoring the use of their funds. By engaging in PLS contracts, Islamic firms will be more efficient as PLS will reduce any excessive lending, increasing the probability of success, which will be reflected into socio-economic well-being at the aggregate level. In their book, Hassan and Lewis (2014) demonstrate how Islam fits “economic life.” The importance of this handbook, as it is not limited to Islamic economics where most of the population are Muslims, instead, this book is considering the world economy, arguing that Muslims are an important part of the world economy. Islam commands authority as it is based on moral and legitimate foundations by shariah, or the Law of Islam, governing how businesses should operate, their accountability and how banking and finance facilitate their operations. Put it differently, Islamic economics apply and integrate shariah with economics in an appropriate manner for a Muslim’s economic behavior. Assuming heterogeneity in responding to two states of sovereign credit risk (low and high default risk), by using threshold vector error correction model (T-VECM), Hassan and Ngene (2012) show evidence of momentum and nonlinearity in sovereign CDS, bond, and equity markets for four OIC countries, in terms of both speed and the magnitudes of the adjustment to equilibrium relationship. The global awareness of sustainability replaced the term of “stockholder-oriented” to “stakeholder-oriented” in firm’s valuation, by including financing, investment, production, and consumption into the valuation relation (Hassan & Saraç, 2020). Therefore, firms are paying more attention to their socio-economic environment, which triggered the need for integrating sustainability into the economic and financial system. Islamic economies have both responsible and sustainable financial system. Hassan and Saraç (2020) elaborate more on this issue via theoretical and empirical academic studies. Theoretically, there is an urgent need to form a theory that considers the uniqueness of Islamic economies. Empirically, studies should focus on testing these theories and concepts, and whether these customized theories fit the data very well. Hassan and Soumaré (2015) suggest a model that considers Islamic project finance, including government guarantees. The rationale of these governments guarantees is to improve the creditworthiness and hence increase the raised capital of these Islamic project finance. Their model

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has several implications on improving access to finance for Islamic finance projects. Hassan and Yu (2007) proposed a set of internationally acceptable standards that can form the basis for the development of the soundness of stock exchanges in OIC countries, regardless of local differences. Specifically, Hassan and Yu (2007) suggest a two-tier system for small-sized and local firms, as these firms will be probably listed in local exchanges, while larger firms will rely more on regional financial centers (or panOIC exchange) regardless of where these markets are located within OIC countries. In a survey paper, Hassan et al. (2019a) divided the literature on Islamic finance into two main categories. Early studies focused on Islamic economic foundation of social fairness and justice, based on Sharia. Successive studies focus on empirical evidence; however, these papers lack the required research analytical and theoretical foundation. A new stream of the literature focus on Islamic corporate finance, or Takaful. Hassan et al. (2019a) concluded that the evidence on Islamic finance is mixed at best, compared to their conventional counterparties. Hassan et al. (2019b) reviewed the literature on Islamic investment, as it represents a type of diversification device. They conclude that the results are mixed, therefore, highlights the need to conduct more empirical studies in the area. Hassan et al. (2020) analyze Bitcoin in terms of conventional and Islamic finance points of view. Hassan (2020) examine whether Bitcoin serves as a conventional currency, as Bitcoin is developed initially as a virtual currency. Authors predict potential qualified cryptocurrencies acceptance as a fiat virtual currency in the long run by both points of view (legal and Shariah). Hassan et al. (2013) stress the importance of Islamic banking and finance globally. This introductory book focuses on the principles and practice of Islamic banking and finance in the world, and covers a widerange of aspects when it comes to Islamic banking and finance, both in theory wise and practical case studies, ranging from professional perspectives, Islamic finance in practice, global Islamic finance and Islamic finance in the news to problems and activities, marginal challenges, and marginal definitions are meant to facilitate the understanding of the underlying principles. Hassan et al. (2010) offer a comparative analysis of Malaysian unit trust funds relative to their non-Islamic counterparties, using multiple

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measures, such as Sharpe, Treynor, Jenson, and Fama’s selectivity, net selectivity and diversification. The authors also examine the persistence of these Islamic funds’ performance, by applying Carhart’s four-factor pricing model. Hassan et al. (2010) concluded that there are no significant differences between Islamic and non-Islamic Malaysian trust funds. However, when controlling performance for style differences, Hassan et al. (2010) find that non-Islamic unit trust funds in Malaysia are valuefocused while Islamic unit trust funds are small-cap oriented. Also, parallel reward to risk and diversification benefits exist between Islamic and nonIslamic Malaysian unit trust funds. In Malaysian unit trust funds, the results suggest that investors will benefit from international diversification, rather than local diversification. Hassan et al. (2018) examine the effect of Shariah board composition on Islamic equity indices’ performance. This paper used CAPM as a benchmark, to analyze the sensitivity of Islamic indices relative to their peers. Hassan et al. (2018) document that the size of the board affects the risk-return of Islamic indices positively. Interestingly, Hassan et al. (2018) find that, when the board members share some commonalities, this would lead to standardization of the screening criteria and similar performance of these Islamic indices. Also, Hassan et al. (2018) find evidence that the educational background of board members affect performance through Jensen’s alpha, while screening criteria of providers affects beta. Hassan et al. (2020) offered a thorough analysis of the existing literature on Takaful. This analysis starts with its growth and ends in products/services and customer perception. Hassan et al. (2018) identified the pioneers in the field and their co-authorship networks. In their book, Hassan et al. (2019c) offer a wide-range of Islamic corporate finance topics. According to the authors, other books are limited to potentials of Islamic banking and finance, and limited cases of financing and investments of Islamic firms. The importance of this books comes from the fact that it offers a global comparison of Shari’ah screening, dividend policy and capital structure of Islamic firms, and Islamic equity and debt market trends and performance. Hassan et al. (2019d) constructed an Islamic business scorecard that covers financial, ethical, and social responsibility aspects of Islamic firms. This scorecard combines two screens: qualitative and quantitative. Hassan et al. (2019d) tested their scorecard using 200 random Malaysian listed firms and finds that 69% of the firms have complied with the qualitative

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screen, 32.5% have complied with the quantitative screens, and 70% of the firms have survived the overall compliance test. Hassan et al. (2020a) examine the role of Islamic finance in circular economy, and financial sustainability, as Islamic finance has been a pioneer in financing Sustainable Development, which can be a major driver in the transformation toward a circular economy. Hassan et al. (2020a) argue that Shari’ah, Islamic finance principles and Sustainable Development Goals provide a robust guideline for effective transition toward a circular economy. In their survey paper, Hassan et al. (2020b) pointed to an ongoing debate in the literature. One stream of the literature supports Islamic investments over conventional investments, in terms of exclusion of highly risky sectors, such as derivatives and highly leveraged firms. Another stream argues that there this no significant difference between these two types of investments in terms of risk-return schedule. Hassan et al. (2020b) pointed the future research direction toward a better understanding of the Islamic investment. Hassan et al. (2020c) discussed the effects of the recent pandemic, COVID-19, on Islamic finance. According to Hassan et al. (2020c), one of the major effects is increased poverty. This effect is not limited to Islamic social finance, it extends globally. However, Islamic social finance instruments such as zakat (alms), sadaqat (charity), waqf (endowment) provide a helping hand to those in need. The authors discuss various aspects in Islamic social finance after COVID-19 pandemic, such as Sukuk, innovations in Islamic social finance (interaction between Islamic finance and fintech), and Islamic microfinance. In their paper, Hayat and Hassan (2017) examine how the label of Islamic impacts corporate governance. Firms with the label of Islamic, referred to as Islamic firms, typically have low leverage. Since leverage can be a measurement for good governance, one can draw the conclusion that Islamic firms possess better governance. This conclusion is not supported when comparing the governance between Islamic and non-Islamic S&P 500 Firms. No effect for an Islamic label is found, as well. Though the effect is not connected to leverage, when governance is measured by the Bloomberg Governance Disclosure score, a firm with an Islamic label measures around 2 percent higher than other firms for governance quality. Yu and Hassan, in their 2009 paper, look at rational speculative bubbles in OIC stock markets. They use alternative bubble tests, like the fractional bubble tests and duration dependence tests to examine rational

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speculative bubbles. The paper confirms the fact log dividend yields of OIC stock markets are integrated, fractionally. Nonparametric NelsonAalen smoothed hazard functions decrease monotonically. This leads to the conclusion that no strong evidence is found in relation to rational speculative bubbles in OIC markets; however, currency denominations are not taken into consideration. Kayed and Hassan (2010) explore the connection between Islamic values and entrepreneurial activity. The authors desire to determine if the values are effect when attempting to raise the profiles of Islamic entrepreneurship. A random sample of Saudi entrepreneurs living in Riyadh are surveyed via a questionnaire. This questionnaire is designed to gain descriptive views and attitudes of those surveyed on Islamic and conventional entrepreneurship. The individuals questioned state they are committed Muslims who look at entrepreneurship as a economic and religious obligation in terms of halal (lawful) income. This income then contributes to falah (well-being) of the Muslim ummah (nation). Their findings deny the accusation that Islam is against development and modernization. The actions which lead to the current global financial crisis would not have been allowed under an Islamic financial system, according to Kayed and Hassan (2011). They make this claim based on the fact that the actions leading up to the crisis are prohibited by Shariah. The crisis then allows the Islamic financial services industry to be tested in resilience and reliability compared to the conventional finance system. Kayed et al. (2012) review how the global financial crisis leads to shows the issues and vulnerability of the free market. It is argued that Islamic economics have the ability to perform in an ordinary matter and not experience systemic collapse. This means a crisis of the current magnitude would not occur given the international financial markets followed Islamic principles of finance. However, those on the opposing side argue that Islamic banking still needs to be tested in both substance and demonstrate its resilience since Islamic banking is an emerging industry and now occupies a notable proportion of the global finance industry. The paper looks at these problems and attempts to answer essential questions revolving around the role Islamic finance has in the ability to stabilize international financial markets. A panel of 55 Organization of Islamic Cooperation (OIC) counties are considered in order to investigate the relationship between economic growth and financial inclusion. Panels for VAR, IRFs, FEVDS, Granger

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causality, and dynamic panel estimation are used to gather multilateral results. A positive relationship between financial inclusion and economic growth is determined; however, the results vary based on geographic regions. In light of these results, the need to apply different policy directions is prominent. This difference depends on the connection between financial inclusion and economic growth and certain regional aspects. Kim et al. (2020) build the lower level of financial inclusion that Muslim countries possess. Based on this, their paper explores the influence of social inequality and religion on financial inclusion. This is done through the calculation of the financial inclusion indices (FIIs) for 152 countries, of which 48 are OIC countries. Ordinary least square (OLS) is used to investigate the effect of both religion and social inequality factors on financial inclusion. The results show religious factors, religious diversity, and Muslim population have effects on the levels of financial inclusion. Gender inequality, education level, and social opportunity level are all social inequality factors that are also determinants of financial inclusion. For development and growth in business and finance, innovation and product enhancement must happen in the Islamic finance industry. Shariah rules, principles, and framework need to be understood in the process of product development. Consistency is key and must be prevalent in governing the parameters and standards for the new products. Shariah frameworks exist in which to oversee the Islamic finance industry. Also, products should be divided into Shariah base or compliance products. Each of the categories have different features and criteria for the process of development. Securities have their own method of screening and are reviewed by their own index provider as well. Lahsasna et al. (2018) look at forward lease sukuk, typically referred to as Ijarah mawsufah fi dhimmah. They evaluate the structure and rules in which govern forward lease sukuk, as well as the Shariah issues that are presented by issuing this kind of sukuk. Forward lease sukuk is defined by an asset which does not exist at the time the bond is issued. It is then connected to a tangible portfolio which has both Istisna and Ijarah contracts. Sukuk Ijarah is, however, considered to have more advantages due to it being a dynamic instrument in the Islamic capital market. All in all, the topic future lease sukuk is covered in relation to its features, characteristics, structure, issuing process, and secondary market rules. A Profit Sharing Ration (PSR) model issued by Mehri, Hassan, and Jouaber-Snoussi to look at how investors face uncertainty involving fund

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managers. A signaling game framework gives an optimal PSR for absolute risk aversion in both investors and mangers, when dealing with adverse selection. The model explains how the risk aversion of both affects bargaining power. The PSR lets investors determine the actual risk aversion level of their fund managers, not their true type, which is the true management skill and abilities. A higher management fee is also discovered to lead to a higher PSR. Mehri et al. (2020) look at an international collection of Islamic and conventional funds in order to determine the effect a country’s conditions have on fund manager fees. Legal conditions, culture, and political risks show a strong robust effect on these fees. Fixed and performance fees are discovered to be higher for both Islamic and conventional funds in developing countries, which typically have weaker legal settings and more corruption. High political risk leads to lower performance fees, with high fixed fees. Hofstede’s cultural values are determined to have a significant affect on fees. A robust differential effect is discovered between Islamic and conventional funds, as well. Information asymmetry and inventive problems effect both Islamic and conventional venture contracts. The agency relationship between the venture capitalist and manager stems from insufficient information revolving around investment and/or the manager type. Mehri et al. (2017) present a literature review related to the agency problem listed and suggest Profit Sharing Ratio (PSR) theory involving information asymmetry to discuss manager type. The negotiated PSR is used as a screening device. When a PSR is accepted by a manager passed a given critical value, adverse selection is the signal, which relates to the maximum payoff for venture capitalists. Merdad and Hassan (2013) assess the performance and riskiness of Saudi Islamic mutual funds in relation to Saudi conventional mutual funds. To do this, a unique sample of Saudi funds is used and divided up by size, diversity, investment goals, and geographic location. It is discover3ed that locally focused conventional fund portfolios outperform locally focused Islamic fund portfolios for an overall market and during bullish periods. However, in bearish markets, the opposite is true. The Islamic-effect in cross-sectional stock return context is examined by Merdad et al. (2015). First, difference stock returns between Islamic and conventional firms in Saudi Arabia are investigated to determine if the Islamic-effect exists. A negative relationship between Saudi Islamic firms

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and average returns is discovered, referred to as the “negative Islamiceffect.” The authors then look to see if this effect is common, systemic, or undiversified risk factor effecting cross-sectional expected returns through a time-series regression approach. Strong common variation in Saudi stock returns are found in the Islamic risk factor (CMI). Merdad et al. (2010) use a sample of Islamic and conventional mutual funds managed by HSBC to investigate the risk-return behavior. Sharpe, Treynor, Jensen Alpha, and their variations are used as performance measures. The sample period of January 2003 to January 2010 is broken into four periods, full, bull, bearish, and financial crisis. This is done to examine how the two funds perform differently from each other. Conventional firms are discovered to outperform Islamic funds in bullish and full periods but underperform in bearish and financial crisis. Islamic mutual funds are discovered to offer hedging options to investors during economic downturns, because Islamic law enforces restrictions on portfolio selection. The question of whether there are costs associated with investing in Islamic mutual funds is addressed by Merdad et al. (2016). 143 Saudi mutual funds are used as a sample. These funds are divided into portfolios by geography, Shariah compliance, and Saudi market trends. The findings of Merdad et al. (2016) state following Shariah law is a benefit when focused locally, but when taking an international view, costs outweigh the benefits. For Arab-focused Saudi mutual funds, cost nor benefits are seen. Mnif et al. (2020) attempt to measure an investor’s sentiment through three pathways in relation to big data. These three are a search query of a list of words related to Islamic context, the degree of engagement on social media, and the use of a Twitter API using the Naïve Bayes method for classification of positive and negative direction. How these have an effect on market sentiment is evaluated. Price changes are seen through a VAR model and Granger causality analysis. Last, an agent-based simulation through the use of Sequential Monte Carlo method is used to control the Twitter search on Islamic index returns. As a result, all three measures used to study the sentiment on social media show impacts on both contemporaneous and lagged returns on the different Islamic assets used in this study. As the Islamic finance industry continues to grow, through regulatory and supervisory measures must be taken to ensure the products are Shariah compliant. The prohibition of riba (interest-bearing transactions), gharar (excessive risk), and trade of unlawful commodities must be taken

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into consideration. Sukuk has recently become to be a prominent tool in the global Islamic finance industry. This new tool is used as an innovation to debt and investment security. However, there are different regulations and ways of supervising in the capital market, which presents an issue. This chapter written by Oseni and Hassan (2014) examines the current trends in regulation and supervision of sukuk, while also looking at the future direction for a sustainable industry. Oseni and Hassan (2015) observes the governing law clause in Sukuk transactions and how conflicts should be dealt with under Shariah law scholars. Disputes arise from regional and international arbitral institutions and this issue needs immediate consultation. This is the consensus found among several global, prominent scholars who have been involved in the Sukuk structures. Oseni et al. (2016) examines current perception and future prospects of “fatw¯a shopping.” It finds it to be common and effective in crossborder Islamic finance transactions such as sukuk transactions where Shariah experts are consulted. Oseni et al. (2013) states recommendations for European nations, such as France, to restructure and diversify their receding economies because of the European sovereign debt crisis. The paper determines the French economy can benefit from reengineering with further endorsement of Islamic Finance SME (Small to Medium-sized Enterprises); this product focuses on ethical investments and seeks to have a consistently positive growth. Oseni, Hassan and Ali (2020) identifies specific areas and tools that have helped judiciary to shape the industry in line with original value proposition of Islamic Finance intermediation. The authors conclude that judicial function has played the most significant role in ensuring fair, effective, and efficient justice practice via purposive interpretation of contracts, recognition, and enforcement of foreign arbitral awards and judgments, consistency and predictability of outcomes, legal risk mitigation, and facilitation of mediation and arbitral proceedings. Paltrinieri et al. (2019) surveys Sukuk literature to observe the influential aspects that are global, national, economic, social, and political. The paper presents present the co-authorship network and identify three research streams: (1) sukuk overview and growth, (2) sukuk and finance theories, and (3) sukuk and stock market behavior. Rashid et al. (2020) observes monetary policy effect on credit supply, testing between Malaysian Islamic banks and Malaysian conventional

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banks. The authors find existence of a credit channel transmission mechanism in the Malaysian banking system; further, they find that monetary policy affects Islamic banks less and this follows suit with banks being smaller and having more liquidity. Rashid and Hassan (2014) compares standards of ethical identity in Islamic banks in Bangladesh, Malaysia, and the Arab Gulf states, while exploring the difference between ideal and communicated ethical conducts via annual reports. The findings of the study reveal an immediate appeal to develop ethical identity disclosure requirements for Islamic banks. Other areas of special importance include focusing on social and developmental goals, putting Islamic Shariah strategically in the mission and vision statements, enhancing employee welfare policy, and effective Shariah monitoring over banking operations. Rashid et al. (2014) tests asset price valuation in two distinct models: one using macroeconomic variables and the other using macroeconomic and sentiment data. This study reports that interest rates, currency index, and FTSE Bursa Malaysia Composite Index pose greater influence on Islamic price index when compared to industrial production, consumer price index, money supply, and investor sentiment indices. The study unlocks room for new studies on the influence of sentiment in Islamic financial industry. Rashid et al. (2017) studies the quantitative Shariah compliance for the Dhaka Stock Exchange. The study concludes that, on the average, 35%, 79%, and 88% of the selected firms are found to be Shariah-compliant based on debt, liquidity and interest screens, respectively. Sabah and Hassan (2019) presents an Islamic deposit insurance model that shows that government insurer provides strong incentives for banks to take excessive systematic risks, and private insurers can eliminate such incentives by charging a higher fee. Samad and Hassan (2006) evaluates the intertemporal and interbank performance of Islamic bank (Bank Islam Malaysia Berhad [BIMB]) in profitability, liquidity, risk, solvency, and community involvement; and the paper finds that BIMB is relatively very liquid and less risky compared to a group of 8 conventional banks. Selim and Hassan (2019) examines the relationship of the Misery Index (MI) on interest-free monetary policy (IFMP) and interest-based monetary policy (IBMP). The results showed that MI was lower and better in countries where IFMP was adopted when compared to the IBMP counterparts.

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Selim and Hassan (2020) study how central banks increase real GDP and employment when pursuing Qard-al-Hasan-based monetary policy and act as a Lender of Last Resort. This will consequently increase the lending capacity of investment banks to expand deposits and the business line overall. Selim et al. (2019) study how massive capital expenditures (i.e., airports) can be financed with Istisna-Sukuk-based expansionary monetary policy. The paper also shows that Istisna-Sukuk financing will increase output and employment while eliminating public debt and interest payments for the government. Smolo and Hassan (2011) claims that musha¯ rakah mutana¯ qisah (MM; diminishing partnership) technique is more in line with Shari’ah teachings and as such should be used more by Islamic financial institutions. The study indicates that MM possibly has a comparative advantage for both financier and the customer when compared with conventional loans and al-Bay c bithaman al-a¯ jil (BBA). Wahab et al. (2007) analyses the mechanics of the ta’awuni (mutual assistance) and the wakala (agency) system. Shari’a scholars have expressed some misgivings about both approaches, but because of its relative youth these are more urgent in the case of the wakala approach. For this reason, the paper outlines a third model, wakala with waqf fund, that seeks to remain within the wakala framework while incorporating modifications that may render it more acceptable from a shari’a perspective. Yousfi and Hassan (2014) compares Islamic and conventional PE. The main analysis observes similarities and differences between conventional and Islamic private equity. The chapter attempts to provide partial answers to the following questions: What can be learned about Islamic PE, particularly what can be learned about incentives schemes in Islamic financing methods? What are the challenges facing Islamic PE? Zaher and Hassan (2001) provides a comprehensive comparative review of the literature on the Islamic financial system and introduces Islamic financial instruments in order to compare them to existing Western financial instruments and discuss the legal problems that investors in these instruments may encounter. Zaman et al. (2018) advocates that the corporate tax incentive to debt (interest tax shield) be abolished and shifted to equity (dividend tax shield). The authors propose that an optimal dividend payout ratio may lead to aggregate equilibrium among the cost of financing, firm value, and corporate tax contribution to the economy.

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Conclusion

In this chapter, we present the comprehensive review of the previous literature published in important mainstream journals indexed both in Scopus and Web of Science (WOS). The discussion of literature reveals that Islamic financial institutions, in general, have the robust structure of corporate governance, better asset quality, and less exposed to systemic risk than their counterpart. Nevertheless, Islamic finance is also subject criticism, therefore, it is suggested to maintain its ethical identity through its disclosure in annual reports. Further, this study also identifies the differences and compares empirically the risk-return features of Islamic funds, SRI and Christian mutual funds. Moreover, the literature discusses the rules and structure of forward lease sukuk (Ijarah mawsufah fi dhimmah) and also critically analyzed the performance of sukuk and conventional bond along with the nature of firms that prefer sukuk over its counterpart. Lastly, Takaful is discussed from the perspective of its growth, models, governance structure and customer perception toward takaful.

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Alhenawi, Y., & Hassan, M. K. (2013). What does the US REIT market has in store for nonconventional investors? The case of Shariah compliance? Journal of Investing, 22(4), 1–22. https://doi.org/10.3905/joi.2013.22.4.061. Alhomaidi, A., Hassan, M. K., Hippler, W. J., & Mamun, A. (2019). The impact of religious certification on market segmentation and investor recognition. Journal of Corporate Finance, 55, 28–48. https://doi.org/10.1016/ j.jcorpfin.2018.08.012. Alhomaidi, A., Hassan, M. K., Zirek, D., & Alhassan, A. (2018). Does an Islamic label cause stock price comovements and commonality in liquidity? Applied Economics, 50(59), 6444–6457. https://doi.org/10.1080/00036846.2018. 1486023. Alshater, M. M., Hassan, M. K., Khan, A., & Saba, I. (2020). Influential and intellectual structure of Islamic finance: A bibliometric review. International Journal of Islamic and Middle Eastern Finance and Management, 14(2), 339– 365. Al-Suwailem, S., & Hassan, M. K. (2012). An Islamic perspective of financial engineering. In M. K. Hassan & M. Mahlknecht (Eds.), Islamic capital markets: Products and strategies (pp. 385–400). Azmat, S., Hassan, M. K., Ghaffar, H., & Azad, A. S. (2020). State contingent banking and asset price bubbles: The case of Islamic banking industry. Global Finance Journal, 100531. https://doi.org/10.1016/j.gfj.2020.100531. Bekri, M., Hassan, M. K., & Alam, N. (2017). On the dependency structure of Islamic assets. In M. K. Hassan (Ed.), Handbook of empirical research on Islam and economic life. Edward Elgar. Bin Mahfouz, S., & Hassan, M. K. (2012). A comparative study between the investment characteristics of Islamic and conventional equity mutual funds in Saudi Arabia. The Journal of Investing, 21(4), 128–143. https://doi.org/10. 3905/joi.2012.21.4.128. Bin Mahfouz, S., & Hassan, M. K. (2013). Sustainable and socially responsible investing. Humanomics. https://doi.org/10.1108/H-07-2013-0043. Castro, E., Hassan, M. K., Rubio, J. F., & Halim, Z. A. (2020). Relative performance of religious and ethical investment funds. Journal of Islamic Accounting and Business Research. https://doi.org/10.1108/JIABR-04-2019-0084. Chuweni, N. N., Eves, C., Hoang, V. N., Isik, I., & Hassan, M. K. (2017). How efficient are alternative financial institutions? An empirical investigation of Islamic REITs in Malaysia. Journal of Real Estate Literature, 25(1), 107– 139. Dharani, M., Hassan, M. K., & Paltrinieri, A. (2019). Faith-based norms and portfolio performance: Evidence from India. Global Finance Journal, 41, 79– 89. https://doi.org/10.1016/j.gfj.2019.02.001.

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El-Din, S. E. D. T., & Hassan, M. K. (2007). Islam and speculation in the stock exchange. In M. K. Hassan & M. K. Lewis (Eds.), Handbook of Islamic banking (p. 240). Edward Elgar. Elfakhani, S. M., Hassan, M. K., & Sidani, Y. M. (2007). Islamic mutual funds. Handbook of Islamic banking, 256. Elnahas, A. M., Hassan, M. K., & Ismail, G. M. (2017a). Religion and ratio analysis: Towards an Islamic corporate liquidity measure. Emerging Markets Review, 30, 42–65. https://doi.org/10.1016/j.ememar.2016.09.001. Elnahas, A. M., Hassan, M. K., & Ismail, G. M. (2017b). Religion and mergers and acquisitions contracting: The case of earnout agreements. Journal of Corporate Finance, 42, 221–246. https://doi.org/10.1016/j.jcorpfin.2016. 11.012. Erragragui, E., Hassan, M. K., Peillex, J., & Khan, A. N. F. (2018). Does ethics improve stock market resilience in times of instability? Economic Systems, 42(3), 450–469. https://doi.org/10.1016/j.ecosys.2017.09.003. Girard, E. C., & Hassan, M. K. (2008). Is there a cost to faith-based investing: Evidence from FTSE Islamic indices. The Journal of Investing, 17 (4), 112– 121. https://doi.org/10.3905/JOI.2008.17.4.112. Grassa, R., & Hassan, M. K. (2015). Islamic finance in France: Current state, challenges and opportunities. International Journal of Islamic Economics and Finance Studies, 1(1), 65–80. Grira, J., Hassan, M. K., & Soumaré, I. (2016). Pricing beliefs: Empirical evidence from the implied cost of deposit insurance for Islamic banks. Economic Modelling, 55, 152–168. https://doi.org/10.1016/j.econmod. 2016.01.026. Grira, J., Hassan, M. K., Labidi, C., & Soumaré, I. (2019). Equity pricing in Islamic banks: International evidence. Emerging Markets Finance and Trade, 55(3), 613–633. https://doi.org/10.1080/1540496X.2018.1451323. Halim, Z. A., How, J., Verhoeven, P., & Hassan, M. K. (2019). The value of certification in Islamic bond offerings. Journal of Corporate Finance, 55, 141– 161. https://doi.org/10.1016/j.jcorpfin.2018.09.002. Hassan, M. K., Sheikh, S., & Kayhan, S. (2020). Introduction to Islamic banking and finance. World Scientific Press. Hassan, A., Hassan, M. K., Rubio, J., Ozkan, B., & Merdad, H. (2017). Coskewness in Islamic, socially responsible and conventional mutual funds: An asset pricing test. International Journal of Business and Society, 18, S1. Hassan, K., & Mahlknecht, M. (2011). Islamic capital markets: Products and strategies (Vol. 609, p. 452). Wiley. Hassan, K. M., & Girard, E. (2010). Faith-based ethical investing: The case of Dow Jones Islamic indexes. Islamic Economic Studies, 17 (2). Hassan, K., Rubio, J. F., Hassan, M. K., & Merdad, H. J. (2012). Nonparametric performance measurement of international and Islamic mutual

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funds . Accounting Research Journal. https://doi.org/10.1108/103096112 11290176. Hassan, M. K. (2005). Return volatility, predictability and dynamic relationships in the stock markets of the member countries of the organization of Islamic conference, 7. In M. Iqbal (Ed.), Islamic perspectives on sustainable development (pp. 185–213). Palgrave Macmillan. Hassan, M. K. (Ed.). (2016). Handbook of empirical research on Islam and economic life. Edward Elgar. Hassan, M. K., & Aliyu, S., (2018). A contemporary survey of Islamic banking literature. Journal of Financial Stability, 34, 12–43. Hassan, M. K., & Hippler, W. (2014). Entrepreneurship and Islam: An overview. Econ Journal Watch, 11(2), 170–178. Available at SSRN 3263110. Hassan, M. K., & Kayed, R. N. (2009). The global financial crisis, risk management and social justice in Islamic finance. Risk Management and Social Justice in Islamic Finance. Hassan, M. K., & Lewis, M. K. (Eds.). (2014). Handbook on Islam and economic life. Edward Elgar. https://doi.org/10.4337/9781783479825. Hassan, M. K., & Ngene, G. (2012). Momentum and nonlinear price discovery in sovereign credit risk and equity markets of the organization of Islamic Cooperation (OIC) Countries. Jurnal Ekonomi Malaysia, 46(2). Hassan, M. K., & Saraç, M. (Ed.) (2020). Islamic perspectives on sustainable financial system. Istanbul University Press (IUPRESS). Hassan, M. K., & Soumaré, I. (2015). Guarantees and profit-sharing contracts in project financing. Journal of Business Ethics, 130(1), 231–249. https://doi. org/10.1007/s10551-014-2201-0. Hassan, M. K., & Yu, J. S. (2007). The globalization and stock exchanges alliances in organization of Islamic Conferences (OIC) Countries. Review of Islamic Economics, 11(Special Issue), 123–148. Hassan, M. K., Aliyu, S., & Hussain, M. (2019a). A contemporary review of Islamic finance and accounting literature. The Singapore Economic Review, 1– 38. https://doi.org/10.1142/S0217590819420013. Hassan, M. K., Aliyu, S., Paltrinieri, A., & Khan, A. (2019b). A review of Islamic investment literature. Economic Papers: A Journal of Applied Economics and Policy, 38(4), 345–380. https://doi.org/10.1111/1759-3441.12230. Hassan, M. K., Karim, M. S., & Muneezac, A. (2020). A conventional and Shar¯ıah analysis of Bitcoin. Arab Law Quarterly, 1(aop), 1–35. Hassan, M. K., Kayed, R. N., & Oseni, U. A. (2013). Introduction to Islamic banking & finance. Pearson Education Limited. Hassan, M. K., Khan, A. N. F., & Ngow, T. (2010). Is faith-based investing rewarding? The case for Malaysian Islamic unit trust funds. Journal of Islamic Accounting and Business Research. https://doi.org/10.1108/175908110110 86732.

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Hassan, M. K., Miglietta, F., Paltrinieri, A., & Floreani, J. (2018). The effects of Shariah board composition on Islamic equity indices’ performance. Business Ethics: A European Review, 27 (3), 248–259. https://doi.org/10.1111/beer. 12185. Hassan, M. K., Paltrinieri, A., Dreassi, A., Khan, A., & Bahoo, S. (2020). A bibliometric review of takaful literature. International Review of Economics & Finance. Hassan, M. K., Rashid, M., & Aliyu, S. (Eds.). (2019c). Islamic corporate finance. Routledge. Hassan, M. K., Rashid, M., Wei, A. S., Adedokun, B. O., & Ramachandran, J. (2019d). Islamic business scorecard and the screening of Islamic businesses in a cross-country setting. Thunderbird International Business Review, 61(5), 807–819. https://doi.org/10.1002/tie.22038. Hassan, M. K., Alam, A. W., & Sarac, M. (2020a). Circular economy, sustainable development, and the role of Islamic finance. In M. K. Hassan & M. Sarac (Eds.). Sustainability, growth, and finance from Islamic perspective. Istanbul University Press. Hassan, M. K., Aliyu, S., Saiti, B., & Halim, Z. A. (2020b). A review of Islamic stock market, growth and real estate finance literature. International Journal of Emerging Market, Special Issue. Hassan, M. K., Muneeza, A., & Sarea, A. (Eds.). (2020). Impact of COVID-19 and Islamic social finance. Routledge. Hayat, R., & Hassan, M. K. (2017). Does an Islamic label indicate good corporate governance? Journal of Corporate Finance, 43, 159–174. https://doi. org/10.1016/j.jcorpfin.2016.12.012. Hussein, K., & Omran, M. (2005). Ethical investment revisited: Evidence from Dow Jones Islamic indexes. The Journal of Investing, 14(3), 105–126. IFSB. (2020). Islamic financial services industry stability report. Kuala Lumpur, Malaysia: Islamic Financial Services Board. Jung-Suk Yu, M. Kabir, H. (2013). Rational speculative bubbles in the OIC stock markets. IIUM Journal of Economics and Management, 17 (1), 97–131. Kayed, R. N., & Hassan, M. K. (2010). Islamic entrepreneurship: A case study of Saudi Arabia. Journal of Developmental Entrepreneurship, 15(4), 379–413. Kayed, R. N., & Hassan, M. K. (2011). The global financial crisis and Islamic finance. Thunderbird International Business Review, 53(5), 551–564. https:// doi.org/10.1002/tie.20434. Kayed, R. N., Mahlknecht, M., & Hassan, M. K. (2012). The current financial market crisis: Lessons learned, risks and strengths of Islamic capital markets compared to the conventional system. In M. K. Hassan (Ed.), Islamic capital markets: Products and strategies (pp. 359–384).

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Kim, D. W., Yu, J. S., & Hassan, M. K. (2020). The influence of religion and social inequality on financial inclusion. The Singapore Economic Review, 65(01), 193–216. https://doi.org/10.1142/S0217590817460031. Lahsasna, A., Hassan, K. M., & Ahmad, R. (2018). Forward lease Sukuk in Islamic capital markets. Springer. Mehri, M., Hassan, M. K., & Jouaber-Snoussi, K. (2017). Optimal carried interest: Adverse selection in islamic and conventional venture capital and private-equity funds. Emerging Markets Finance and Trade, 53(7), 1458– 1476. https://doi.org/10.1080/1540496X.2016.1166424. Mehri, M., Hassan, M. K., Safa, M. F., & Siraj, I. (2020). Do determinants of fees differ between Islamic and conventional funds? International Journal of Finance and Economics, 1–25. Mehri, M., Jouaber-Snoussi, K., & Hassan, M. K. (2017). Profit-sharing ratio as a screening device in venture capital. In M. K. Hassan (Ed.), Handbook of empirical research on Islam and economic life. Edward Elgar. Merdad, H. E. S. H. A. M., & Hassan, M. K. (2013). Islamic mutual funds’ performance in Saudi Arabia: Contemporary Islamic finance: Innovations, applications, and best practices (pp. 303–322). Merdad, H. J., Hassan, M. K., & Hippler, W. J., III. (2015). The Islamic risk factor in expected stock returns: An empirical study in Saudi Arabia. Pacific-Basin Finance Journal, 34, 293–314. https://doi.org/10.1016/j.pac fin.2015.04.001. Merdad, H., Hassan, M. K., & Al-Henawi, Y. (2010). Analysis of Islamic versus conventional mutual funds in Saudi Arabia. Journal of King Abdul Aziz University, Islamic Economics, 23(2), 161–198. Merdad, H., Hassan, M. K., & Khawaja, M. (2016). Does faith matter in mutual funds investing? Evidence from Saudi Arabia. Emerging Markets Finance and Trade, 52(4), 938–960. https://doi.org/10.1080/1540496X.2015.102 5655. Mnif, E., Jarboui, A., Hassan, M. K., & Mouakhar, K. (2020). Big data tools for Islamic financial analysis. Intelligent Systems in Accounting, Finance and Management, 27 (1), 10–21. https://doi.org/10.1002/isaf.1463. Oseni, U. A., & Hassan, M. K. (2014). The regulation and supervision of sukuk in global capital markets. In M. K. Hassan (Ed.), Handbook on Islam and economic life. Edward Elgar. Oseni, U. A., & Hassan, M. K. (2015). Regulating the governing law clauses in Sukuk transactions. Journal of Banking Regulation, 16(3), 220–249. https:// doi.org/10.1057/jbr.2014.3. Oseni, U. A., Ahmad, A. U. F., & Hassan, M. K. (2016). The legal implications of ‘Fatw¯a shopping’in the Islamic finance industry: Problems, perceptions and prospects. Arab Law Quarterly, 30(2), 107–137.

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Oseni, U. A., Hassan, M. K., & Matri, D. (2013). An Islamic finance model for the small and medium-sized enterprises in France. Journal of King Abdul Aziz University: Islamic Economics, 26(2), 157–186. Oseni, U., Hassan, M. K., & Ali, N. (2020). Judicial support for the Islamic financial services industry: Towards reform-oriented interpretive Approaches. Arab Law Quarterly. Paltrinieri, A., Hassan, M. K., Bahoo, S., & Khan, A. (2019). A bibliometric review of Sukuk literature. International Review of Economics & Finance, 69, 389–405. https://doi.org/10.1016/j.iref.2019.04.004. Rashid, A., Hassan, M. K., & Shah, M. A. R. (2020). On the role of Islamic and conventional banks in the monetary policy transmission in Malaysia: Do size and liquidity matter? Research in International Business and Finance, 52, 101123. https://doi.org/10.1016/j.ribaf.2018.10.006. Rashid, M., & Hassan, M. K. (2014). Market values of Islamic banks and ethical identity. American Journal of Islamic Social Sciences, 31(2), 43–79. Rashid, M., Hassan, M. K., & Yein, N. Y. (2014). Macroeconomics, investor sentiment, and Islamic stock price index in Malaysia. Journal of Economic Cooperation and Development, 35(4), 219–234. Rashid, M., Hassan, M. K., Amin, N., & Samina, Q. S. (2017). Shari’ah compliant companies in Bangladesh. Journal of Islamic Economics Banking and Finance, 13(2), 129–143. Sabah, N., & Hassan, M. K. (2019). Pricing of Islamic deposit insurance. Economics Letters, 178, 91–94. https://doi.org/10.1016/j.econlet. 2019.01.013. Samad, A., & Hassan, M. K. (2006). The performance of Malaysian Islamic bank during 1984–1997: An exploratory study. International Journal of Islamic Financial Services, 1(3), 1–14. Selim, M., & Hassan, M. K. (2019). Interest-free monetary policy and its impact on inflation and unemployment rates. ISRA International Journal of Islamic Finance. https://doi.org/10.1108/IJIF-06-2018-0065. Selim, M., & Hassan, M. K. (2020). Qard-al-Hasan-based monetary policy and the role of the central bank as the lender of last resort. Journal of Islamic Accounting and Business Research. https://doi.org/10.1108/JIABR12-2017-0190. Selim, M., Hassan, M. K., & Rahman, M. (2019). Financing super-infrastructures using ISTISNA-SUKUK based monetary policy for faster economic development. Journal of Economic Cooperation & Development, 40(4), 139–161. Smolo, E., & Hassan, M. K. (2011). The potentials of mush¯arakah mutan¯aqisah for Islamic housing finance. International Journal of Islamic and Middle Eastern Finance and Management. https://doi.org/10.1108/175383911 11166476.

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Wahab, A. R. A., Lewis, M. K., & Hassan, M. K. (2007). Islamic takaful: Business models, Shariah concerns, and proposed solutions. Thunderbird International Business Review, 49(3), 371–396. https://doi.org/10.1002/tie.20148. Yousfi, O., & Hassan, M. K. (2014). Moral hazard in Islamic profit–loss sharing contracts and private equity. In M. K. Hassan (Ed.), Handbook on Islam and economic life. Edward Elgar. Zaher, T. S., & Kabir Hassan, M. (2001). A comparative literature survey of Islamic finance and banking. Financial Markets, Institutions & Instruments, 10(4), 155–199. https://doi.org/10.1111/1468-0416.00044. Zaman, Q. U., Hassan, M. K., Akhter, W., & Meraj, M. A. (2018). From interest tax shield to dividend tax shield: A corporate financing policy for equitable and sustainable wealth creation. Pacific-Basin Finance Journal, 52, 144–162. https://doi.org/10.1016/j.pacfin.2017.01.003.

CHAPTER 6

The Role of Islamic Finance in Achieving Sustainable Development Goals (SDGs) Mohamad Akram Laldin and Fares Djafri

1

Introduction

The concept of sustainable development has been articulated for the first time in the Brundtland Report, also called “Our Common Future” published in 1987 by the World Commission on Environment and Development (WCED) and supported by the United Nations (UN). According to Brundtland Report, Sustainable Development is defined as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” In 2015 the United Nations has introduced the new global development agenda for 2015 through 2030 and adopted a set of seventeen Sustainable Development Goals (SDGs) for the action of the member states. According to UNDP, The SDGs as global agenda represents a

M. A. Laldin (B) · F. Djafri International Shari’ah Research Academy for Islamic Finance (ISRA), INCEIF University, Kuala Lumpur, Malaysia e-mail: [email protected] F. Djafri e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8_6

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universal framework for comprehensive development. It aims to plan for a better and sustainable future and address the global challenges faced by people and the planet. Prominent among the goals are eradication of poverty, deal with climate and environmental degradation, improve human health and education, and a range of other goals across the environmental and socio-economic development. One of the most salient factors that challenge the achievement of SDGs by 2030 is the shortage of financial resources. Several reports and studies stated that around US$ 5–7 trillion dollars are required every year to achieve SDGs, which cannot be obtained from the government or even from the donor agencies. In other words, there is a huge gap between the available resources and fund requirements to achieve the SDGs. Thus, SDGs will have very substantial resource implications across developed and developing countries. For instance, in developing countries alone, the required investment for the Sustainable Development Goals would be approximately US$ 2.5–3 trillion per year for food security, basic infrastructure (road, water and sanitation, and power station), health and education, and climate change mitigation. Because of the new development agenda, all possible resources must be mobilized if the world is to succeed in achieving the SDGs. Thus, the potential for Islamic finance to play a key role in supporting the Sustainable Development Goals is vital. Ismail (2016) noted that SDG goals and values have parallel relevance and application with Islamic Finance practice. Iqbal (2018) mentioned that SDGs provides opportunity for Islamic finance to offer an alternative method in addressing the problem faced by the society to improve communities through investment and business that is ethical, responsible, and sustainable. Hence, this impose a great responsibility on Islamic financial institutions (IFIs) to innovate new products and services that may contribute to the efforts of mobilizing resources to realize the SDGs. This study adopts a qualitative method of inquiry and utilizes the inductive method and content analysis to explore the potential for Islamic finance in supporting the Sustainable Development Goals (SDGs). Four dimensions are taken into consideration, namely overview of Shariah and SDGs, the role of Islamic finance in achieving SDGs, assessing Islamic financial products and their contribution in achieving SDGs, and case studies on Islamic finance and SDGs.

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Overview of Shariah and SDGs

Shariah is defined as divine laws for Allah’s creatures concerning the belief, worship, ethics, transactions, and code of life with all its various ramifications that govern their relationship with their creator, mankind, and the universe (Al-Qatan, 2001). It is also defined as the sum of commandments and divine laws relating to belief and conduct which adoption in Islam has been made compulsory to attain its welfare objectives in the community (Al-Zarqa, 1998). From the above definitions, it can be concluded that Shariah encompasses a set of divine laws concerning the belief, moral, and conduct of human beings, deduced from the Qur¯an and the Sunnah. In addition, the Shariah is more than just a set of laws in the modern sense. It encompasses a set of welfare objectives which are manifested in ethical and moral values. The ethical and moral values are in place to ensure the welfare of human being. This clearly stated by Imam Abu Hamid Al-Ghazali, a great Islamic scholar from the early centuries, in his illustration of maqasid’s holistic approach when he said: The very objective of the Shariah is to promote the well-being of the people, which lies in safeguarding their faith (d¯ın), their lives (nafs ), their intellect (‘aql ), their posterity (nasl ), and their wealth (m¯ al ). Whatever ensures the safeguarding of these five serves public interest and is desirable, and whatever hurts them is against public interest and its removal is desirable.

Ibn al-Qayyim echoed the same perspective when he said: Shariah is based on wisdom and achieving people’s welfare in this life and in the hereafter. Shariah is all about justice, mercy, wisdom and good. Thus, any ruling that replaces justice with injustice, mercy with its opposite, common good with mischief, or wisdom with nonsense, is a ruling that does not belong to the Shariah even if it is claimed to be so according to some interpretations.

Therefore, the objective of Shariah (Maqasid al-Shariah) entails a holistic approach that aims to elevate humanity to the highest rank by making them upright, spreading virtue among them, establishing public

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interest, fighting the promotion of harm, and ensuring balanced relationships between the self, the community, and the universe in which people live. One of the trends in Shariah is ensuring sustainability of the universe and the preservation of the environment and several socio-economic development issues. These considerations are in line with the objective of Shariah which aims to bring benefit to mankind and prevent harm from them and are also part of broad ethical values propagated by Shariah. In other words, Islam as a religion of peace with its ultimate goal to be a blessing for mankind has persuaded nations—over 1400 years—for implementing Sustainable Development Goals (SDGs) such as; preserving the environment, promoting fairness, and establishing justice in all aspects, community development, consumer protection, and good governance. To elaborate, in Islam, the preservation of the environment entails preserving the environment’s resources by properly utilizing and maintaining them and by prohibiting their extravagant use and destruction or depletion without necessity or significant need. Preserving the environment is classified by scholars as an auxiliary objective (maqsad taba‘i) to the objective of preserving wealth. However, they emphasize that, from a certain perspective, it transcends all the essential objectives of the Shariah. The preservation of religion, for instance, is based on the principle of stewardship and maintenance of the earth, and the first degree of this stewardship is to make the earth flourish and make it physically sound by preserving the environment in which humans carry out their activities. In other words, Islam has established a clear worldview on the environment. It promotes a comprehensive and harmonious notion of the environment and links it with the concept of harnessing (taskh¯ır). The Qur’an emphasizes that the environment includes everything in the heavens and the earth. Allah says: He has subjugated for you whatever there is in the heavens and whatever there is in the earth. (al-Qur’an 45:13)

This implies that all the natural elements are harnessed and directed to serve human beings in their journey toward their Creator. In addition, the environment is created by Allah to serve the human race and to enable them to serve the duty of stewardship. This is what is meant by deployment and harnessing (taskh¯ır). Various verses have shown how heavenly

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bodies are subjected in their movements to serve humans. The Qur’an says: Have you not considered that Allah has subjugated for you what is in the heavens and what is on the earth, and has perfected His blessings on you, both outward and inward? (al-Qur’an 31:20)

Moreover, Shariah clearly prohibits excessive emission of pollutants into the air. This proscription is supported by core Islamic legal maxims, namely: Harm shall neither be inflicted nor reciprocated.

This maxim is a word-for-word quotation from the Prophet (PBUH) that has been adopted as a legal maxim. The related Islamic legal maxim says: “Harm is to be eliminated.” Likewise, the International Islamic Fiqh Academy issued its Resolution No. 185 (11/19) on “The Environment and Its Protection from the Islamic Perspective” condemns any harm inflicted on the environment and further states: All acts and behaviours that entail any harm to the environment or abuse thereof are prohibited; for example, acts and behaviours that lead to the disruption of environmental balance, or that target or use resources unfairly without regard to the interests of future generations. [This judgment is] in accordance with the Shariah maxims on the necessity of eliminating harm.

Besides that, Shariah has legislated a number of rules and ethical codes that aim to achieve benefits (maslahah) to community development, human capital, consumer protection, provide quality education and eradicating poverty. For instance, there are ample items of evidence that demonstrate Shariah’s emphasis on community development. The Qur’an states in Surah al-Ma’idah: Help one another in righteousness and piety, and do not help one another in sin. (al-Qur’an 5:2)

In this regard, a corporation is to facilitate community development in the crucial areas such as education, entrepreneurship, provision of charity, and empowerment. Regarding education, a corporation is encouraged to educate local communities to become a knowledge-based society.

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Likewise, corporations can provide charity under their Corporate Social Responsibility (CSR) program. In this respect, corporations with Muslim shareholders can choose to pay zakat or donate cash waqf (endowment), which are two financial instruments that are deemed very effective in eradicating poverty. There is ample Shariah evidence for the merits of giving charity. Allah, the Exalted, has promised—and He is the Generous who does not break His promise—to compensate those who spend for His sake. Allah says: Say, ‘My Lord gives in abundance to whichever of His servants He will, and sparingly to whichever He will; He will replace whatever you give in alms; He is the best of providers.’ [al-Qur’an 34:39]

Based on the aforementioned, Shariah is a comprehensive concept that encompasses a set of welfare objectives which is manifested in ethical and moral values. These ethical and moral values are in place to ensure the welfare of human being. Over 1400 years, Shariah has legislated a number of rules and ethical codes that aim to implement sustainable development goals such as the principle of environmental preservation, development of the community, eradicating poverty and hunger, and many other sustainable development goals. The next section will discuss the role of Islamic finance in achieving SDGs.

3

The Role of Islamic Finance in Achieving SDGs

In the wake of challenges facing the global financial landscape in today’s world, the global financial system could capitalize from a new banking and financial paradigm, that is based on the concept of risk-sharing, social justice and that is linked directly to the real economy. According to the Global Report on Islamic Finance (2017), Islamic finance is structured by nature to service this new paradigm, and thus could help addressing the environmental, social and governance (ESG) issues related to sustainable growth and support the adoption of the Sustainable Development Goals (SDGs). In other words, Islamic finance has a lot in common with impact investment and can play a major role in addressing the problem faced by society. It also has the potential to bring add value to the efforts to mobilize resources for the sake of realizing the SDGs. Ismail (2016) stated that SDGs provide Islamic finance with an opportunity to redefine

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their role pertaining to people empowerment, socio-economic development, and the environment. The Islamic financial sector has the potential to contribute to the achievement of the SDGs through creative and productive modes of financing. Likewise, Ahmed et al. (2015) mentioned that the role of Islamic finance in realizing SDGs can be enhanced if the broader goals of Shariah are integrated into its operations. Though, SDGs will have very substantial resource implications across developed and developing countries. For instance, in developing countries alone, the required investment for the Sustainable Development Goals would be approximately US$ 2.5–3 trillion per year for food security, basic infrastructure (road, water and sanitation, and power station), health and education, and climate change mitigation. According to UKIFC report (2020): The global financial system potentially has the size, scale and level of sophistication to finance sustainable development. However, available finance is not being deployed at the scale and speed required to achieve the SDGs. The financing gap needed to achieve the SDGs in developing countries is estimated to be US$ 2.5-3 trillion per year.

One of the areas that can enhance the contribution of the Islamic finance sector to the SDGs is through philanthropic instruments such as zakat, waqf, and sadaqah. Unlocking the potentials of Islamic finance by introducing innovative products such as waqf, zakat, and sadaqah could improve financial inclusion, financial sector stability; and ultimately, enhance the contributions of Islamic finance to the SDGs. Raza (2018) stated that there is a need to mobilize the private sector and philanthropic organizations to support the governments in the accomplishment of the SDGs. Philanthropy is considered the third sector of the economy, which could play a major role in realizing the SGDs such as reducing the vulnerability of the poor and develop education and health sectors. Historically, awqaf have played an essential role in providing education, financing infrastructure, medical care, and many other necessities throughout the Islamic civilization. Cash waqf has long proven its efficiency in making waqf an effective tool for social finance (The World Bank Group Report, 2019). Further, the application of zakat can be used also to reduce vulnerability and enhance the resilience of the poor. To explain more, cash waqf is now actively used in many Muslim countries as an effective tool for social finance and welfare programs

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such as promoting educational scholarship and healthcare facilities. For instance, in Malaysia, several Islamic banks promote and practice cash waqf known as Islamic banks assisted cash waqf. For instance, Bank Muamalat Malaysia Berhad (BMMB) introduced a cash waqf scheme in collaboration with Perbadanan Wakaf Selangor (PWS) (Selangor Waqf Corporation). Besides, BMMB launched the first shariah-compliant debit card called “Aisya Debit Card-I.” It is a first of its kind in Malaysia and the world as it incorporates spending with social responsibility features. The bank (BMMB) has decided that part of the fee income accrued to the bank from the interchange fee received from the merchant will be contributed to waqf (BMMB, 2016). Likewise, Maybank Islamic announced the establishment of a waqf fund of RM20 Million in collaboration with the Federal Territory Islamic Religious Council. While declaring this donation, Maybank Islamic affirmed that profits realized from the portfolio will be used to develop education, health care, infrastructure, and development of young entrepreneurs.1 In addition, the preservation of environmental and socio-economic development issues has been the focus of renewed investor attention, as shown by the growing interest in renewable and clean energy as well as socially responsible investment (SRI). According to Ahmed et al. (2015), the role of the Islamic financial sector in addressing environmental and social goals is either small or non-existent. Therefore, framing the issue of SDGs and social responsibility through the introduction of socially responsible investment, such as SRI Sukuk, as a Shariah-compliant funding instrument, can play a major role in addressing the environmental and socio-economic development issues. In terms of mobile banking and payment systems, Islamic finance institutions have the opportunity to offer Shariah-compliant Internet-based banking platforms. For example, Malaysia has launched an Investment Account Platform (IAP) which is envisaged to become a cross-border multicurrency channel linking into regional and global economies. The IAP is backed by Islamic banking institutions via the offering of Investment Account (IA) to the investors. Through this platform, Islamic banking institutions will facilitate the matching of investments with the

1 Maybank Islamic, “Maybank Islamic announces RM20M Waqf Fund,” New Straits Times Online, 28 October 2014.

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identified ventures or projects that are in need of funding.2 The first venture listed under IAP is Perak Transit Berhad (Perak Transit), an integrated transportation terminal and public transportation services provider based in Ipoh, Perak. The investment will be in the form RM10 million Term Financing Facility for three years. The return expected to investors is 6.5% per annum. The proceeds raised from the facility will be utilized by Perak Transit and its group of companies for its working capital requirements (Bank Muamalat, 2016).

4 Assessing Islamic Financial Products and Their Contribution in Achieving SDGs Islamic finance is one of the fastest-growing segments of the global financial industry, from US$ 200 billion in 2003 to an estimated US$ 1.8 trillion in 2015, with global assets expected to surpass US$ 3.7 trillion by 2022 (IFSB report, 2018). Despite the fact that Islamic finance has been growing, its contribution to SDGs remains small. According to Asutay (2007) Islamic finance has not fulfilled much in social impact, sustainability, human-centered economic growth, and development. This is also supported by SDG Index and Dashboards Report (2019), which states that the whole Muslim countries do not score high in term of SDG attainment, ranking an average score of 58 out of 100. This opens the door to question the role of Islamic finance in achieving the development of societies at different levels. In addition, Islamic finance has been criticized for being focusing more on the legal compliance aspect of the products and overlooking the philosophical foundation of Islamic economics which emphasizes on social justice, ethical finance, and human well-being. In other words, Islamic finance industry is criticized for the minimal social impact and sustainability that has created, along with missing the Islamic economic system foundations such as social justice, human-centered economic growth, and development (I-FIKR, DIGEST, 2019). Mohamad and Borhan (2017) mentioned that the Islamic finance industry is seen to be more technical, legalistic, and stressing on form rather than substance, and mimicking conventional products. Likewise, Hassan and Cebeci (2012) condemn the excessive dependence of Islamic banking on Murabaha-based financing, which favors individual interest over social interest. Having said that, there

2 https://iaplatform.com/.

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are ongoing efforts and various initiatives that have been considered to reinforce ethics and social justice in Islamic finance. This includes various sustainable development instruments such as Sustainable and Responsible Investments (SRI), principles of environmental, social and corporate governance (ESG), and value-based intermediation (VBI) initiated by the Malaysian Central Bank. Altogether, these initiates aim to play an important role in the preservation of the environment and several socioeconomic development issues (Laldin, 2020). The following section will discuss various sustainable development instruments such as SRI, ESG, VBI, and its role in achieving sustainable development goals (SDGs). 4.1

Sustainable Development Instruments

Sustainable, responsible, and impact investing (SRI) is an investment discipline that avoids investments in controversial industries such as tobacco, gambling, alcohol, and arms companies, and seeking out for companies that engage in social justice, environmental sustainability, and alternative green energy. Similarly, Environmental, Social, and Corporate Governance (ESG) refers to the three key factors—corporate governance and the environmental and social impact of a business’ activities—when measuring the sustainability and ethical impact of an investment in a business or company. In other words, ESG is a generic term used in capital markets and commonly used by investors to evaluate the behavior of companies, as well as determining their future financial performance. Ansary et al. (2017) noted that ESG reflected a shift from an explicitly ethical basis for evaluating business activities to a pragmatic consideration of factors that affect a business’s long-term profitability and sustainability. In line with the international trend of incorporating other values other than just profit, the Central Bank of Malaysia developed a strategy paper on Value-Based Intermediation (VBI) in 2018. It is an intermediation function that aims to deliver the intended outcomes of Shariah through practices, conducts, and offerings that generate positive and sustainable impacts to the economy, community, and environment, consistent with stakeholders’ sustainable returns and long-term interests. It advances a rationale of “not just Shariah compliance” to establish a culture that establishes the intended outcomes of Shariah (BNM, 2018). According to BNM (2018, p. 6), VBI is defined as:

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an intermediation function that aims to deliver the intended outcomes of Shari’ah through practices, conduct and offerings that generate positive and sustainable impact to the economy, community and environment, consistent with the shareholders’ sustainable returns and long-term interests.

This definition signifies that The VBI initiative aims in creating an enabling environment for Islamic banking institutions (IBIs) in Malaysia by focusing on the sustainable impact to the economy, community, and environment without compromising the financial returns to shareholders. In his keynote address at the 15th Kuala Lumpur Islamic Finance (KLIFF) 2019, Tun Dr. Mahathir Bin Mohamad, Prime Minister of Malaysia, mentioned: the industry’s move towards embracing VBI would further strengthen Malaysia’s leadership position and advance the growth of Islamic finance towards generating positive, sustainable impact to the economy, community and environment.

It should be noted that VBI shares similarities with several wellestablished concepts such as Environmental, Social and Corporate Governance (ESG), Ethical Finance and Sustainable, Responsible, Impact Investing (SRI), specifically on the intended outcomes. However, the underlying reason for VBI is its reliance on Shariah in determining its underlying values, moral compass, and priorities. VBI’s launch was intended to position Islamic finance to become more prominent and leading agent of positive change for the financial system and operates within a network economy that is built upon shared values of integrity, inclusivity, and sustainability (BNM, p. 14). VBI is another attempt to integrate Islamic finance with maqasid al-Shariah and the values propagated are also in line with ethical considerations in Shariah. 4.2

Case Studies on the Contributions of Islamic Finance Toward SDGs

This section provides some examples that exemplify how Islamic finance and sustainable development instruments can be linked to SDGs. Case 1: End Poverty in all its Forms Everywhere (Goal 1)

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Unlocking the potentials of Islamic finance by introducing innovative products such as waqf, zakat, and Islamic microfinance could play an efficient role in poverty alleviation and ultimately enhance the contributions of Islamic finance to the SDGs. In Malaysia, for instance, Amanah Ikhtyar Malaysia (AIM’s) as the largest microfinance institution in the state, has helped thousands of poor and deprived Malaysians to improve their living standard through the provision of interest-free microcredit facilities. Besides, it assists their lives by extending financing for them to start their own activities and enterprises. According to Asian Institute of Finance Report (2015) on financial inclusion through sustainable development: Amanah Ikhtyar Malaysia has enhanced the income of more than 22% of the beneficiaries and more than 49,000 of them have surpassed the income level of RM3500 a month and succeeded to become microentrepreneurs. Therefore, Islamic microfinance can be used for poverty alleviation and enhance the resilience of the poor as most Muslim countries have a high level of poverty. In addition, Islamic social finance such as zakat and waqf can play a great role in poverty alleviation and enhancement of social and economic development including education, health care, and infrastructure development. In fact, Islamic social finance instruments have been adopted and applied outside the Muslim world as a role model, exemplified by the establishment of Merton College through waqf at the University of Oxford. Therefore, the institution of zakat and waqf could help in providing support to needy and poor people who are struggling to meet basic needs and may lead to the achievement of sustainable goals. Case 2: Ensure Healthy Lives and Promote Well-being for All at All Ages (Goal 3) The main objective of this goal is to ensure healthy lives and promote well-being for all at all ages. It is reported that 17,000 fewer children die each day than in 1990, but more than six million children still die before their fifth birthday each year. Since 2000, measles vaccines have averted nearly 15.6 million deaths. Over 6.2 million malaria deaths have been averted between 2000 and 2015, primarily of children under five years of age in sub-Saharan Africa.3 The question is then, can Islamic finance play a role in achieving this goal?

3 https://www.un.org/sustainabledevelopment/.

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It is worth noting that the International Finance Facility for Immunisation Company (IFFIm) issued sukuk worth US$ 500 million for children’s immunization in the world’s poorest countries through Gavi, the company of Vaccine Alliance. This landmark transaction is the first socially responsible sukuk with funds to be utilized for this purpose. Also, it is directly aligned with the UN Sustainable Development Goal; which aims to end preventable deaths of new born and children under 5 years of age by 2030. Moreover, awqaf is considered as an important Islamic instrument and can directly be used for poverty alleviation and financing other SDGs mainly education and healthcare sectors. For instance, Bank Muamalat Malaysia Berhad (BMMB) introduced a cash waqf scheme which used to develop education, health care, infrastructure, and development of young entrepreneurs. Similarly, Waqf can be used to assist the under privileged to have access to healthcare at minimum costs. For example, in Malaysia, Waqaf An-Nur Corporation has set up a network of hospitals and waqf clinics called the Klinik Waqaf An-Nur (KWAN). Up to January 2019, there is one hospital (Hospital Waqaf An-Nur in Pasir Gudang) and 6 clinics in Johor, 2 clinics each in Sarawak and Negeri Sembilan, 8 clinics in Selangor, one clinic each in Perak, Penang, and Kelantan as well as 5 mobile clinics. The charges for outpatients are a mere RM5 and for dialysis treatment, the charges are RM90 compared to private dialysis centers charging RM150 to RM200 per session. Since 2017, the management and supervision of these hospitals and clinics have been handed over to KPJ Healthcare Bhd. As at the end of 2017, the KWAN network has treated 1,443,674 patients and among this number 116,859 (8%) are non-muslims. Case 3: Ensure Inclusive and Quality Education for All and Promote Lifelong Learning (Goal 4) The main objective of this goal is to ensure free, equitable, and quality primary and secondary education. Ensure equal access for all women and men to affordable and quality education and upgrade education facilities and environments. To achieve this goal, Khazanah Nasional Berhad issued SUKUK IHSAN as Malaysia’s first Sustainable and Responsible Investment (SRI). The proceeds from Sukuk issuance which is exclusively targeted institutional investors were channelled to Yayasan AMIR, a notfor-profit organization incorporated in 2010 to improve the accessibility of quality education in Malaysian government schools. It has reached

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over 65,000 students, 83 trust schools, across 10 states in Malaysia.4 This shows that Islamic finance can be used positively to enhance and promote quality education. In the same way, zakat can play a vital role in providing quality education. In many Muslim majority countries, there are mosque-based schools which effectively channelize zakat funds to ensure religious and secular education. Effective management of zakat can play a crucial benefit in terms of boosting institutions to create synergistic effects (Ahmed Shaikh and Ismail, 2017). Likewise, financial assistance can be given to the poor students in the form of benevolent loan (Qard Hasan) out of the zakat fund. This financial assistance shall be refundable out of the income generated upon one’s graduation and the ultimate goal of this refund is to increase the zakat fund and help other destitute and poor students (Billah, 2016). Case 4: Ensure access to affordable, reliable, sustainable, and modern energy (Goal 7) The Paris Agreement on Climate Change and the 2030 Sustainable Development Goals mark a key turning point for a global stable and sustainable society. One of the most important provisions of those agreements is to face climate changes, environmental degradation, and to promote affordable and green energy. More importantly, the use of “green” energy has become an integral part of the UN’s Sustainable Development Goals (SDGs), which have been incorporated into the economic growth plans of many nations. In addition, the preservation of environmental and socio-economic development issues has been the focus of renewed investor attention, as shown by the growing interest in renewable and clean energy as well as socially responsible investment. According to the Bloomberg NEF report, global investment is focusing strongly on investing in renewable and clean energy. For example, investments into global green energy have recorded an increase from US$ 200 billion in 2008 to US$ 332 billion in 2018. Further, affordable and clean energy has a direct impact on economics and social development and can contribute to several policy objectives, such as developing new industries and products, creating new jobs, reducing emissions of polluting gases, and providing affordable and reliable clean energy.

4 https://www.khazanah.com.my/About-Khazanah/Our-Case-Studies/Khazanah-360/ Sukuk-Ihsan-.

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Several countries have recently witnessed a remarkable development in renewable energy investments. In the countries of the Gulf Cooperation Council (GCC), for example, the renewable energy target has become an integral part of national determined contributions and falls within the objectives of the United Nations Framework Convention on Climate Change (UNFCCC). Besides, the issuances of green bonds have become part of the current forms of financing for green energy projects. In the field of Islamic finance, SRI sukuk have emerged as a Shariah-compliant instrument for the same purpose and seek to finance environmentally friendly green projects and enhance the SDGs through funding infrastructure projects. Malaysia and Indonesia are among the first countries to issue this type of sukuk. In Malaysia, the first SRI sukuk, valued at 250 million ringgits, was issued to partly finance large-scale solar construction. Following that, Quantum Solar Park Malaysia Sdn Bhd launched the world’s largest green SRI sukuk valued at RM1 billion to fund the construction of Southeast Asia’s largest solar photovoltaic plant project in three regions: Kedah, Melaka, and Terengganu. Indonesia has also recently issued USD 1.25 billion of green sovereign sukuk, whose revenues will be partly used to finance renewable energy projects. It is worth noting that the increase in the adoption of green sukuk to finance renewable energy projects is attributable to the following factors: the increase in renewable energy projects, particularly solar energy projects, the low capital costs, and the fact that it is a Shariah-compliant instrument (Laldin, 2019). Therefore, SRI sukuk, as a Shariah-compliant funding instrument, can play a major role in addressing the threat faced by the environment and has the potential to bring additionality to the efforts of ensuring access to affordable, reliable, sustainable, and modern energy. Case 5: Build Resilient Infrastructure and provide clean water and sanitation (Goal 9 and 6) The aim of this goal is to invest in infrastructure—transport, irrigation, energy, and information and communication technology to achieve sustainable development and empowering communities in many countries. According to the UN (2016) report, basic infrastructure like roads, information and communication technologies, sanitation, electrical power, and water remains scarce in many developing countries. About 2.6 billion people in the developing world are facing difficulties in accessing electricity full time.

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Sukuk as a creative mode of financing can be used to enhance this through funding infrastructure projects. For instance, in Malaysia, DanaInfra Nasional Berhad issued the DanaInfra Retail Sukuk to finance the extension of the capital city’s Mass Rapid Transit (MRT) rail network. The company has raised a total of RM2.5 billion (US$ 789.14 million) by selling three tranches of Sukuk of RM1.6 billion, RM300 million, and RM400 million with tenors of 7–20 years.5 Philanthropic instruments such as zakat—as a creative mode of financing—can also be used to enhance this goal through funding infrastructure projects. For instance, in Indonesia, zakat has supported the construction of Micro Hydro Power Plant (PLTMH) to provide electricity for a total of 806 households from 4 villages in Jambi province (Ahmed, 2019). This is the first support by the National Board of Zakat, known locally as Badan Amil Zakat Nasional (BAZNAS), to use the zakat fund of $350,000 for the provision of electricity and to contribute to the achievement of the SDGs through creative and productive modes of financing. Therefore, zakat, as a Shariah-compliant funding instrument, has the potential to bring additionality to the efforts of ensuring access to affordable and sustainable infrastructure. Besides that, one of the most remarkable initiatives to provide clean water and sanitation is BAZNAS Water and Sanitation Project in Boyolali, Indonesia. BAZNAS comes up with an innovative program which aims to construct private lavatories for underprivileged households. It was implemented as a scheme between BAZNAS and the local government in November 2018 to construct toilets for 40 households. Prior to this project, the local residents had difficulties to access to the sources of water which are primarily the nearby river and rainwater. This has led the local people to develop unhealthy traditions such as open defecation, and as a result, diarrhea has frequently affected residents (Hudaefi et al. 2020). Another initiative worth noting is the launch of a new fund to combat cholera and other diarrheal diseases in the most affected OIC Member Countries. The project is a collaboration between the Islamic Development Bank (IsDB) and the International Federation of Red Cross and Red Crescent National Societies (IFRC). The initiative aims to strengthen and integrate the delivery of water, sanitation, and hygiene (WASH) with health services to combat cholera and other diarrheal diseases. The WASH Fund uses an innovative financing

5 http://www.danainfra.com.my/.

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mechanism designed to attract new philanthropic and private investor capital in addition to traditional humanitarian donor financing. This fund structure would then be increased in size through the issuance of a Sukuk enabling it to operate at multi-million-dollar scale. This initiative aligns with the objectives of SDGs which aim to provide good health as well as clean water and sanitation.

5

Conclusion

Islamic finance can play a major role in addressing the problem faced by society and has the potential to bring additionality to the efforts of mobilizing resources for the sake of realizing the SDGs. The establishment of Islamic finance is not merely in offering financial products that are Shariah compliant, but also in the ability to offer financial products that contribute to the environment and socio-economic development. In other words, the establishment of Islamic finance is purported to achieve various socio-economic justice as mandated by the objective of Shariah (Maqasid al-Shariah) which aims at realizing human well-being and prevent harm and difficulties to the general public and complying to the ethical norms propagated by Shariah. In order to achieve this, there is a need to re-orient financial strategy to ensure financial access to all dimensions of society and hence promoting wealth distribution, equality, and social mobility. This should be done by incorporating innovative products as a potential tool that could enhance financial inclusion and intermediation, reducing risks and vulnerability of the poor and more broadly contributing to financial stability and development. Equally important is to unlock the potentials of Islamic social finance instruments such as waqf, zakat, and sadaqah which will rank supreme due to their potential in instilling cooperation, solidarity, and alternative finance. In addition, Islamic finance has a lot in common with impact investment and can leverage on the infrastructure provided for SDGs to develop new sustainable products. In order to achieve this, there is a need to establish an enabling environment which includes strengthening the regulatory frameworks, develop products, policies, prudential requirements and standardization of contracts and Shariah rulings. Besides, the maqasid discussion in the financial sphere should be extended to integrate various sustainable development instruments (i.e., SRI, ESG and VBI) and provides a grand framework on the integration between and SDGs

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and Maqasid al-Shariah and the direction of how financial transactions should be arranged in an Islamic economic system. By pursuing sustainable development instruments such as SRI sukuk and Shariah-compliance hand-in-hand, the Islamic finance industry would benefit from a larger investor base and gain broader mainstream relevance.

References Ahmed, M. (2019). How Traditional Islamic Giving Can Play a Role in the Future of Aid. World Economics Forum. Retrieved from https://www.wef orum.org/agenda/2019/05/islamic-social-finance-humanitarian-aid-charityclimate-change/. Ahmed, H., Mohieldin, M., Verbeek, J., & Aboulmagd, F. W. (2015). On the Sustainable Development Goals and the Role of Islamic Finance. Policy Research Working Paper, 7266. Al-Qatan, M. (2001). Tarikh Al Tashri Al-Islami. Maktabah Wahbah. Al-Zarqa, M. (1998). Al-Madkhal al-Fiqhi al- Amm. D¯ar al-Qalam. Ansary, R., Sairally, S., Habib, F., & Furqani, H. (2017). Islamic Finance and Sustainable and Responsible Investment (SRI): An Ethical Dimension, International Shari’ah Research Academy for Islamic Finance (ISRA), Kuala Lumpur. Asian Institute of Finance report. (2015). Financial Inclusion Through Sustainable Development: The Case of Amanah Ikhtyar Malaysia. Asutay, M. (2007). Conceptualisation of the second-best solution in overcoming the social failure of Islamic finance: Examining the overpowering of homoislamicus by homoeconomicus. IIUM Journal in Economics and Management, 15(2), 167–195. Bank Muamalat. (2016). Press release. Retreived from https://www.muamalat. com.my/downloads/media-room/press/2016/PR-BANK_MUAMALAT_D ebit_Card_Launch_2016.pdf. Bank Muamalat, Inaugural Listing on The Investment Account Platform (IAP) of Perak Transit Berhad by Bank Muamalat Malaysia Berhad. Press release, 2016. http://www.muamalat.com.my/downloads/media-room/ press/2016/PR_Bank_Muamalat-Iap-Listing-26-ApriL-2016.pdf. Bank Negara Malaysia. (2018). Value-Based Intermediation: Strengthening the roles and impact of Islamic finance. Billah, M. M. S. (2016). Creating an eco-sustainable community: The role of zakat. International Journal of Zakat, 1(1), 1–16. Hassan, K., & Cebeci, I. (2012). Integrating the social maslaha into Islamic finance. Accounting Research Journal, 25(3), 166–184.

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Hudaefi, F. A., Saoqi, A. A. Y., Farchatunnisa, H., & Junari, U. L. (2020). Zakat and SDG 6: A case study of BAZNAS, Indonesia. Journal of Islamic Monetary Economics and Finance, 6(4). I-FIKR, DIGEST. (2019). In-Person Professor Mehmet Asutay, ISRA, Kuala Lumpur. Retrieved from https://ifikr.isra.my/library/pub/10339. Iqbal, Z. (2018). SDGs Digest, A Quarterly Newsletter, the voice of the IsDB Community of Practice (CoP) on SDGs, Issue 6. Retrieved from https://icd-ps.org/uploads/files/SDG%20Digest%20Issue% 206%20Final%201220181545898136_7592.pdf. Islamic Financial Services Board. (2018). Islamic Financial Services Industry Stability Report. Kuala Lumpur. Ismail, A. G. (2016). Sustainable development goals and the role of Islamic finance. Paper delivered at the 2016 Quarterly Islamic Finance Public Lecture IRCIEF-IRTI. Laldin, M. A. (2019). The role of SRI Sukuk in supporting SDGs. IFN News Magazine. Laldin, M. A. (2020). Ethics in the light of Maqasid Al-Shari’ah: A case study of Islamic economics and finance. Published in Handbook of ethics of Islamic economics and finance (pp. 21–47). De Gruyter Oldenbourg. https://doi. org/10.1515/9783110593419-002. Mohamad, S., & Borhan, N. A. (2017). Islamic finance and social sustainability: Parameters for developing a model for social impact measurement. Malaysian Journal of Sustainable Environment, 3(2), 81–103. Raza, S. M. A. (2018). SDGs Digest, A Quarterly Newsletter, the voice of the IsDB Community of Practice (CoP) on SDGs, Issue 6. Retrieved from https://icd-ps.org/uploads/files/SDG%20Digest%20Issue% 206%20Final%201220181545898136_7592.pdf. SDG Index and Dashboards Report. (2019). Arab Region. Emirates Diplomatic Academy (EDA). Retrieved from https://s3.amazonaws.com/sustainabledeve lopment.report/2019/2019_arab_region_index_and_dashboards.pdf. Shaikh, S. A., & Ismail, A. G. (2017). Role of zakat in sustainable development goals. International Journal of Zakat, 2(2), 1–9. The Global Report on Islamic Finance for. (2017). Islamic finance: A catalyst for shared prosperity. Co-authored by the Islamic Development Bank (IDB) and the World Bank. Retrieved from file https://www.islamicfinance.com/wp-con tent/uploads/2020/08/WB-Catalyst-for-Shared-Prosperity.pdf. The World Bank Group, INCIEF, and ISRA Report. (2019). Maximizing social impact through Waqf Solutions. UKIFC Report. (2020). Islamic finance and the SDGs: Framing the opportunity: Thought leadership series Part I. Retrieved from https://www.ukifc.com/ wp-content/uploads/2020/05/ISLAMIC-FINANCE-AND-THE-SDGS-% E2%80%93-THOUGHT-PAPER-1-13052020.pdf.

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UN. (2016, July). Global sustainable development report 2016. Department of economic and social affairs. New York. Retrieved from https://www.undp. org/.

CHAPTER 7

Islamic Finance and SDG 10: Evidence from Selected OIC Countries Hylmun Izhar and Murat Munkin

1

Introduction

The way financial system is set up can be very central for an efficient resource allocation. History has shown that the financial system is determined by the nature of financial intermediation. The rapid development in financial system has made financial intermediary more important in the economy. The acquisition and processing of information about economic agents, the packaging and repackaging of financial claims, and financial contracting are among the activities that differentiate financial intermediation from other economic activities. The nature of intermediation has changed drastically over the last five decades due to the changes in macroeconomic policies, liberalization of capital accounts,

H. Izhar (B) Islamic Development Bank Group, Jeddah, Saudi Arabia e-mail: [email protected] M. Munkin College of Arts and Sciences, Department of Economics, University of South Florida, Tampa, FL, USA e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8_7

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deregulation, and advances in financial theory as well as breakthroughs in technology. Lending based operations which characterize traditional banking activity has been replaced by more fee-based services that bring investors and borrowers directly in contact with each other. Financial intermediation in the form of traditional banking—mainly based on the operations of lending—has declined considerably in developed countries where market-based intermediation has become dominant. In Islamic history, financial intermediation has established a historical record and has made significant contributions to economic development over time. The simplest manifestation of financial services within the early Muslim states took the form of money-changers (sayarifah; sing., sarraf ) who were also partially engaged in the holding of deposits and the shortterm financing of trade (Chapra & Khan, 2000). Yet a more sophisticated form of banking finance for trade and government was represented by the jahabidhah (sing., jahbadh) who practiced much of the modern financing activities under the supervision of the Muslim state (Chachi, 2005). In the highly developed market economy of the Abbasid State, jahabidhah bankers proliferated throughout the state, even though they were mostly of Jews who enjoyed the status of Ahl al-Kitab origin (People of the Book) within the early Muslim state. The jahabidhah were basically trade vendors who concurrently practiced business of financing and commercial transactions to others. Banking operations were therefore ancillary to primary mercantile operations, yet they seemed to have grown to sizeable banking functions particularly when the jahabidhah accepted deposits in efforts to augment their own businesses. The high streets of Basra were so much supplied with money-changers and jahabidhah that the banking network in Basra was rightly called by a Western historian ‘the Wall-Street of the Middle Ages’ (Heck, 2006, p. 113). The famous Persian historian, Nasir-i Khusraw, was reported to have estimated the number of jahabidhah bankers in the state of Isfahan alone at 200 financial institutions (Heck, 2006, p. 113). It was such a complex network of banking activities that the call for appropriate government supervision and regulation was acknowledged by the Islamic state. To this effect, the Abbasid State established a central banking agency in year 316 H/929 A.D called Diwan al-Jahabidhah to foresee the performance and growth of banks within the empire. A similar central bank was established in Egypt by the Fatimid State by the name Dar al-Mal in the commercial capital of al-Fustat to supervise an equally intense jahabidhah banking activity in Fatimid Egypt. Among the most commonly practiced banking instruments were the sakk (the Arabic root of ‘cheque’) and the suftajah

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(which combined features of traveller cheques and letters of credit), the hawalah (which is a means credit transfer), wadi’ah (i.e., deposit), and ruq’ah (which was a sort of promissory note). The use of cheque (sakk) was particularly known since the time of the Rightly-Guided Caliphs. A renowned historian, Ibn Abdel-Hakam, reported that Umar ibn alKhattab paid for the grains delivered to the state warehouses by cheque and that he used to pay government wages by cheques signed by his treasurer Zaid ibn Thabit (Izhar, 2010). This study has the following primary components: section two briefly discusses about the nature and origin of Islamic banks. Whereas sections three depicts the state of Islamic financial services industry, followed by four sub sections which analytically deliberates upon the issues such as (1) an inevitable shift toward the east, (2) current outlook of IFSI, (3) analysis of IFSI from a microeconomics perspective, and (4) analysis on whether IFSI has fulfilled its promises. Section 4 discusses income inequality in economic literature. Section 5 presents the empirical analysis, and the conclusion is spelled out in Sect. 6.

2

Nature and Origin of Islamic Banks

The existence of an Islamic bank in the present days, hence, is believed to be a modern transformation of jahbadh.1 As a matter of fact, such transformation started to materialize in Mit Ghamr, Egypt from 1963 to 1967 when there was an initiative by Mit Ghamr Savings Bank to mobilize small savings from the rural sector largely through savings account without any interest payment to the account holders. It was followed by the establishment of Nasser Social Bank in 1971, Dubai Islamic Bank and Islamic Development Bank as the first international Islamic financial institution in 1975. Moreover, Islamic banking industry witnessed a very rapid growth surpassing US$100 billion worth during 1980–1990 (Iqbal & Molyneux, 2005). Having been regarded as an alternative financial intermediary with profit and loss sharing contract (in mudarabah and musharakah contract) as its cornerstone, an Islamic bank is, theoretically, expected to bring more stabilization and efficiency in resource allocation. In addition to that, an Islamic bank is also equipped with contracts which may, slightly,

1 See Chachi (2005), Chapra and Khan (2000), Izhar (2010), and Heck (2006).

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look similar to what a conventional bank has been commonly practising; i.e., debt financing (in murabahah contract). Nevertheless, the nature of debt in an Islamic bank is qualitatively different from that of conventional bank since debt contract in an Islamic bank requires to be tied to some underlying assets (Ahmed, 2005). Furthermore, a debt contract in Islamic financing scheme is not a riba–based contract, in contrast with the concept of a debt contract in conventional perspective. Consequently, the distinctive contractual structure that an Islamic bank embodies necessitates different treatment on the management of the operational system of an Islamic bank. As a modern form of jahbadh, an Islamic bank is an institution offering financial services which conforms with shariah. A set of shariah principles governing the operations of Islamic banks are (i) prohibition of dealing with interest (riba); (ii) financial contracts must be cleared from contractual uncertainty (gharar); (iii) exclusion of gambling (maysir) in any financial activity; (iv) profit must not be originated from haram economic and financial activities (prohibited industries such as those related to pork products, pornography, or alcoholic beverages); (v) each financial transaction must refer to a tangible, identifiable underlying asset; and (vi) parties to a financial transaction must share in the risks and rewards attached to it. The principles mentioned above must be, conceptually, inherent in Islamic banks, in order to distinguish them from conventional banks.

3

State of Islamic Financial Services Industry (IFSI)

The central pillars of global financial system have endured a persistent scrutiny in the wake of the continuous changing international economic and political environment. Islamic financial institutions are demonstrating resilience as the world events continue to reshape the landscape of global financial services. The key matter, however, will be the way through which IFSI prepares itself for the opportunities and challenges posed by such a changing global economy. IFSI has demonstrated a remarkable growth, outpacing the growth of its conventional counterparts. The growth, as Islamic Finance Development Report (IFDR) 2017 forecast, is even expected to reach 9.5% per year on average, taking total assets to USD 3.8 trillion by 2022. Such data is based on disclosed assets by all Islamic finance institutions (full sharia-compliant as well as those with Sharia “windows”) covering commercial banking, funds, sukuk, takaful,

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and other segments. The IFSB Stability Report 2019 indicates that the breakdown of IFSI by sector can be decayed as follows. Data are mostly taken from primary sources (regulatory authorities’ statistical databases, annual reports, and financial stability reports, official press releases including the IFSB’s prudential and structural Islamic Financial Indicators Database). And for the purpose of regional classification, IFSB Stability Report 2019 excludes Iran in “MENA (ex. GCC),” while Turkey is included in “Others.” The global Islamic banking industry experienced only 0.9% growth in assets to close at approximately USD 1.57 trillion [2Q17: USD 1.56 trillion] and thus its share in the overall IFSI has slightly contracted to 71.7% [2017: 76%]. This lackluster growth over the period is due mainly to the depreciation of local currencies in terms of the USD, especially in some emerging economies with a significant Islamic banking presence. The major declines of asset values among the Islamic banking jurisdictions are in Iran and Sudan, which are among the largest Islamic banking asset domiciles. As for the tak¯aful industry, the gross contributions of the global tak¯aful industry also recorded a 6.1% increase to close at USD 27.7 billion as at end-2017 [2016: USD 26.1 billion], however its share in the global IFSI remains unchanged at 1.3% [SR20186: 1.3%]. IFSB Stability Report 2019 also lists out twelve (12) jurisdictions where Islamic finance has achieved domestic systemic importance in 2Q18, which is consistent with 2Q17. Furthermore, the two jurisdictions with more than a 50% share for Islamic banking—aside from Iran and Sudan—have further increased market penetration. Brunei continued as the most prominent, where Islamic banking now accounts for 63.6% [2Q17: 61.8%] of the domestic market. Saudi Arabia had a consistent penetration of a 51.5% share in 2Q18 [2Q17: 51.5%]. Improvements in market share were also made across other systemically important jurisdictions, including Kuwait at 40.6% (2Q17: 39.3%), Malaysia 26.5% (2Q17: 24.9%), UAE 20.6% (2Q17: 20.0%), Bangladesh 20.1% (2Q17: 19.8%), and Jordan 15.6% (2Q17: 15.5%). Qatar was still the only important jurisdiction that experienced a decline in market share, to 25.2% (2Q17: 25.7%). Collectively, the 12 systemically important Islamic finance jurisdictions are now host to a slightly decreased 91% of the global Islamic banking assets (2Q17: 92%) and also a slightly decreased 80% of the global s.uk¯uk outstanding (2Q17: 82%) (IFSB SR, 2019).

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Regionally, the GCC continued as the largest domicile for Islamic finance assets; in 2018, the region experienced a modest increase in its share in global Islamic finance assets to 44.9% (SR2017: 42.0%).2 The share of MENA excluding GCC (MENA ex-GCC) has also increased moderately to 34.4% (SR2017: 29.1%). Asia is the only region that showed a decreased market share of the global IFSI, to 16.9% (SR2017: 24.4%), although asset values are increasing. In terms of the top jurisdictions for Islamic banking assets, Iran sustained its historical position as the largest market, accounting for a slightly decreased 32.1% of the global Islamic banking industry in 2Q18. This is followed by Saudi Arabia at 20.2% (2Q17: 20.4%), Malaysia 10.8% (2Q17: 9.1%), UAE 9.8% (2Q17: 9.3%) and Kuwait 6.3% (2Q17: 6.0%), which complete the top five. In 2018, Malaysia in particular experienced an increase of estimated Islamic financing market share by about 71%, which became the key driver of the growth of Islamic finance in the region. The other countries in the top 10 Islamic banking jurisdictions, in order of size, are Qatar, Turkey, Bangladesh, Indonesia, and Bahrain (IFSB SR, 2019). Overall, the global IFSI is well placed to maintain its positive growth trajectory, experiencing asset increases across all three of its main component markets. Despite the slower growth due to the depreciation of local currencies, which affected the Islamic banking asset values, the market has managed to increase the value of its assets, from the USD 2 trillion mark it attained for the first time in 2017 to USD 2.19 trillion. More importantly, it has achieved domestic market share entrenchment for its Islamic banking sector in at least 20 countries. 3.1

Inevitable Shift Toward the East

Such astounding growth and development prospects, one way or the other, have accelerated the eastward shift in the world’s economic “centre of gravity.” Economies of the Middle East and Asia, as a result, are inevitably seen as vital. The Group of 20—a summit that plays a key role in international economic policy—now includes three OIC member countries (Indonesia, Turkey, and Saudi Arabia).

2 SR2017 refers to IFSB Stability Report 2017.

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The eastward shift, hence, creates numerous opportunities for Islamic finance industry, including (a) managing the savings and wealth being created, (b) supporting ongoing economic growth by providing financing, and (c) exercising increased influence in global forums and decision-making bodies. These global forums include both forums that have traditionally been dominated by Western economies (such as the G20, International Monetary Fund [IMF], and World Bank) and new forums that provide greater focus on emerging economies in the Middle East, Asia, and Africa. Investigating from the viewpoint of the significance of oil sector in their respective economies, countries within the MENA region can be classified into two groups; i.e., (1) oil exporting, and (2) oil importing countries. It doesn’t come as a surprise that all GCC states belong to the former group, while Egypt, Jordan, and Lebanon are in the latter. Among the GCC states, Saudi Arabia has the highest proven oil reserves and is thus the most oil-dependant economy. Bahrain, on the other hand, has minimum reserves with oil contributing approximately 26% to its GDP. With shrinking oil resources as well as the realization that oil-based economy cannot be sustained over the long term, the six GCC countries have followed the strategy of economic diversification. Typically, the lack of diversified economy is characterized by three main categories— the oil sector’s contribution to gross domestic product (GDP), its share of total exports, and share of government fiscal revenue. In an attempt to amplify such a realization, the Kingdom of Saudi Arabia recently launched a breakthrough initiative, namely the 2030 vision.3 The latest development in KSA for instance, is the operationalization of VAT effective from 1 January 2018. Many would argue that the magnitude of economic progression in the years to come is likely to be adversely impacted, should a persistent diversified economy is not aptly addressed and overcome. As such, it is viewed that the penetration level of Islamic finance to other non-oil sector might also be hindered although the potential of non-oil sector cannot simply be taken lightly, especially from the economic regional perspective. In a study on economic interconnectivity in GCC countries for instance; Cashin, Mohaddes, and Raissi shows that there are sizeable positive spillover effects from non-oil activity in Saudi Arabia. The model

3 Although its key success will depend primarily on the implementation of 2030’s vision.

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demonstrates that a one percent increase in Saudi non-oil GDP is estimated to increase GDP in its neighbor countries such as Jordan, Lebanon, Syria, and in other GCC countries by between 0.2 and 0.4 percent (IMF, 2012). This also shows an enormous potential in which Islamic finance can play its role in non-oil sector, especially when taking into account its faster growth average in the region. Since 2008, the world has also witnessed waves of successive financial crises. Ranging from institutional crises (e.g., the failure of Lehman Brothers) to systemic crises (e.g., the virtual collapse of European debt markets) to sovereign debt and currency crises (e.g., fundamental challenges to the euro-zone), the very pillars of the global financial system have been shaken up. The ongoing financial crises have certainly prompted a high level of re-questioning of the conventional financial system. This creates an unprecedented opportunity for IFSI to contribute to a global dialogue on the very nature of the robust and resilient financial system which would, hopefully, generate developmental impact on the society. This opportunity has been further bolstered by (1) the increased clout of member countries (three of which are members of the influential G20), and (2) the active attention the industry has already received in international commentaries on the financial system. Some observers believe the IFSI has not played an active enough role in the dialogue—further underscoring the present opportunity. Indeed, contributing to the global dialogue cannot only boost IFSI industry itself, but it can also pave the way for it to have genuine impact on the broader financial system by sharing and transferring valuable principles. 3.2

What is the Current Outlook of IFSI?

Many are of the view that IFSI commenced with an introduction of Islamic banks in the mid-1970s. In the very beginning stage, the operationalization of Islamic banks were underpinned by the principle of two-tier mudaraba; that is on the liabilities side of the balance sheet, the depositor would be the financier and the bank the entrepreneur; and on the assets side, the bank would be the financier and the person seeking funding for the entrepreneur. Currently, however, the bulk of assets and liabilities are predominantly inhabited by murabaha modes of finance.

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Following “a four-stage” evolution, that is composed of four distinct phases: (1) the early years (1975–1991); (2) the era of globalization (1991–2001); (3) the post-September 11, 2001 period; and (4) an era after the 2008 global financial crisis (Izhar et al., 2018); an important question which timely begs for an investigation is “where does the IFSI currently stand?” 3.3

IFSI from the Perspective of Microeconomics

In order to address this question, let us first of all revisit El-Gamal’s depiction on how IFSI has been shaped over time (El Gamal, 2000). Using a microeconomic analysis, as shown in Fig. 1a, he portrays the indifference curves of fuqaha (jurists) that are assumed to be geared toward equity (al-‘adl ) relative to the weight given to considerations of economic efficiency (al-kafa’a al-iqtisadiyya). El Gamal contends that such indifference curves by jurists are based on the manifestations of their understanding of the objectives of Islamic law (maqasid al-sharia). In contrast, it is assumed that the preferences of bankers are more biased toward considerations of efficiency relative to those of Islamic jurists. Hence, the latter preferences are drawn more vertical than the former. The nature of different preferences between jurists and bankers are clearly depicted in Fig. 1a which shows two axes, labeled “efficiency” and “equity,” reflecting the trade-offs in any economic system between efficiency (the size of the economic pie to be shared by economic

Fig. 1 Indifference curve of IBF stakeholders a. Initial set of preferences of Islamic finance stakeholders; b. Current set of preferences of Islamic finance stakeholders

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agents) and equity (how justly, and how equally, the pie shares are determined). Another element in Figs. 1a and 1b is financial technologies that render certain types of contracts and transactions feasible. Each technology allows for linear trade-offs between efficiency and equity by simply allowing for redistribution schemes. The Shariah boundary, namely Shariah Compliant Frontier is drawn as a convex set. This is to signify the Islamically permissible set of allocations within the frontier. While El-Gamal’s analysis is insightful at the time, such a delineation may no longer reflect the current preferences of IFSI stakeholders. We would argue that the jurists have become more pragmatic in their approach; therefore, their indifference curves, we believe, have shifted toward more efficiency (see Fig. 1b). What makes things more interesting now is that the bulk of indifference curves located at the Southeast region of Fig. 1b does not only correspond to jurists, but also to denote the preferences of bankers and lawyers. The explanation is very simple and straight forward: the bankers need Shariah scholars (who also are the employees of the banks) to endorse their products; subsequently they will need lawyers to make the products legal and hence can be offered in the market. Moreover, since financial technology evolved; in response to the secular financial needs of economies worldwide, it tends to cater to the banker, jurists, and lawyers preferences, thus producing the status quo tangency point Q, in the Southeast part of the figure, which affords society a high level of economic efficiency, at the expense of low levels of equity (see Fig. 2). The Muslim economists, in contrast, who are now known as being more concerned about the realization of maqasid al shariah aims to describe and analyse the point that is optimal to Islamic economics and finance, that is the tangency point E in the Northwest region (shown in Fig. 2). Nonetheless, recognizing the difficulties surrounding the development of a financial technology that passes through the ideal point E, Muslim economists may compromise by turning to point D, at which the preferences are maximized subject to the current financial technologies constraints; although this point can easily be viewed by as socially inefficient. Point I, located at the intersection of the current financial technology and the permissibility frontier, is perhaps closer to the current reality of IFSI as it may be relatively easy to accomplish. This is due to the increasingly prominent role of Shariah scholars in driving the era of Islamic financial engineering.

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Fig. 2 Optimal preferences

3.4

Has IFSI Fulfilled Its Promises?

Despite having undergone ‘a four-stage evolution’ mentioned above, the Islamic financial services industry is still perceived to have failed to deliver its promises on fairness, equity, and inclusion. As such, this has been due to the industrialization along with its inevitable commercialization along the way. Rightly so, the contemporary age of Islamic financial engineering that has been characterized by a greater reliance on plugging “classical Islamic financial contracts” into an Anglo Saxon based banking model and a conventional securitization technique in Sukuk issuance has proven to have made Islamic finance appear to be having no different than its conventional counterpart. Such an era, which commenced in midnineties has been considerably exacerbated by the introduction of; first, wa’ad technique (especially double wa’ad) applied to Islamic financial contracts. The white paper by Deutsche Bank in 2007 was perhaps the first documented articulation on the use of double wa’ad in contemporary Islamic financial engineering (Deutsche Bank, 2007). Second, the deployment of commodity murabaha through the use of tawarruq for both liquidity management and personal financing purposes. Third, the operationalization of the concept of beneficial ownership (Haneef, 2005), and the extension of the khulta (mixture) principle to the field

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of commercial transactions (Thomas & Adam, 2004); of which Islamic capital market through sukuk issuance has undoubtedly the great beneficiary of the implementation of such concepts. These three components have altered the profile or body of Islamic financial contracts resulting in the financialization of the entire Islamic financial services industry. In the process, one of the unpreventable outcomes is a “shift” in the natural domain of contract; from initially being classified as a benevolent contract to now being a commercial contract; one example is kafalah contract; upon which a fee is now permissible (Bakar, 2016). This is possible since in the contemporary practice, kafalah has essentially been molded into ‘shirkatul wujuh’ using the principle of tab’iyyah 4 or subordination. Financialization, as Palley contends, is a process whereby financial markets and financial institutions gain greater influence over economic policy and economic outcomes leading to a supreme superiority of financial sector over real sector (Palley, 2007). The consequential impacts of this process would be (a) an elevated significance of the financial sector relative to the real sector; (b) income transfer from the real sector to the financial sector; (c) increase income inequality; and (d) propagation of debt creation instead of wealth creation. Having said the above, it has become clear that under the existing commercial institutional set-up, reducing inequalities and being more inclusive have never been the ultimate “natural” objective of Islamic financial institutions; hence it may not necessarily be attainable. Nowadays, where the innovations are characterized by the use of artificial intelligence (AI), fintech, and internet of things (IoT), or collectively known as the Fourth Industrial Revolution; Islamic finance, being in its 5th phase of development, is encountered with the situations where such innovations are creating substantial displacements in industry and employment in major economies around the globe. It is imperative; therefore, that Islamic finance has no other choice but to change. Furthermore, there is also a genuine demand and opportunity to redirect innovations toward services and products that create more economic opportunities, jobs, and financial inclusion for those who have been on the sidelines of the Islamic finance revolution. Coincidentally, we are witnessing the propagation of Environmental, Social, and 4 The authors are grateful to Dr. Sami Al Suwailem for his explanation on tab’iyyah concept.

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Governance (ESG) discourse, which refers to the three central factors in measuring the sustainability and ethical impact of an investment in a company or business; combined with proliferation of the immense potential of Islamic Social Finance. The terminology Islamic Social Finance itself was only prominently introduced in 2014 by Islamic Research and Training Institute through its Islamic Social Finance Report.5 A change of the look and direction in the industry is needed. Malaysia’s recent movement of Value Based Intermediation in Islamic finance can be considered as evidence of such change. Another one is the issuance of Khazanah sustainable and responsible investment (SRI) sukuk. Waqf linked sukuk is another breakthrough championed by the Ministry of Finance Indonesia in partnership with Badan Wakaf Indonesia (BWI) and Bank Indonesia. It is becoming apparent that the drivers of the change now is no longer driven by an entirely profit geared motive; rather it emphasizes upon creating social and environmental impact. In other words, it is an admission that the deviations caused by the operation of Islamic finance in relation to the expected or aspired paradigmatic knowledge, theory, and institutional emergence have to be corrected. One way to do that is through the introduction of ESG, Impact Investing, and Islamic Social Finance. More importantly, in the wake of the industrial revolution 4.0 that is somewhat synonymous with the use of technology and digitalization; we could perhaps hope it would pave the way for Islamic finance to be more appealing for not only its inclusivity but also the universality of its fundamental principles as an ethical, socially responsible, and fair system of finance not just for Muslims but for the whole world.

4

Income Inequality in Economic Literature

Current economic development around the world has been accompanied with rising income inequality across most of the countries, which in turn has led to political instability. Indirect evidence of that is outcomes of elections in most of the developed countries with populist winning the elections on the platforms of economic nationalism usually blaming globalization for economic problems and promising a retreat to national

5 IRTI, Islamic Social Finance Report, Islamic Research and Training Institute (2014).

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economies, emphasizing local needs. Unlike politicians, economists point to technological advances especially in the IT industry as the main culprit in contributing to income inequality. There is no consensus on the causes of inequality even among economists. However, what they agree on is that inequality within countries is higher than what it was 25 years ago (World Bank, 2016, p. 2). Often overlooked is the fact that the share of financial services in real economies around the world has been at historical maximums. Philippon and Reshef (2012) report that much of the increase in financial activity has not come from traditional finance but from services created for purely speculative purposes. Bolton et al. (2016) argue that a significant portion of these new services simply increase transaction costs for the real economy, even though technological advancements should have decreased them. Philippon (2012) says, that “Technological improvements in finance have mostly been used to increase secondary market activities, i.e., trading. Trading activities are many times larger than at any time in the previous history.” He also points out that financial transaction costs in the U.S. financial sector was only 1.6 cents on the dollar immediately after World War II but climbed to 2.4 cents on the dollar in 2011. Stiglitz (2015) defines financialization as the growth of the financial sector and its dominance over the real sector. He states that financial sector’s power to influence values and practices on the rest of the society has contributed substantially to growing inequality. The main objective of the financial sector is to allocate capital to those activities, which are most productive and socially useful. However, as it currently stands the financial sector has devised various mechanisms and has developed complicated products reducing its main function to extracting rent. In many cases, customers simply do not understand these products. Stiglitz (2012, p. 41) points out that financial services are “getting income not as a reward to creating wealth but by grabbing a larger share of the wealth that would otherwise have been produced without their effort” (p. 41). Piketty et al. (2018) state that in the United States in 1980 the average income of the top 1 percent was 27 times that of the bottom 50 percent, but it was 81 times in 2018. The share of income of the bottom 90 percent has decreased from 20 percent in 1980 to 12 percent in 2018, while that of the top 1 percent has increased from 12 percent to 20

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percent for the same period. That is a redistribution of 8 percent of income or roughly $2 trillion from the bottom to the top. The role of financialization in this redistribution of income is often ignored as noted by Epstein (2005) but that is how it works. Piketty et al. (2018) further state that the top 0.1 percent or 234,400 households own as much wealth as owned by the bottom 90 percent or 210,960,000 households. Their conclusion is that in the last 30 years in the United States financialization is the main contributing factor in the rising wealth and income inequality.

5

Empirical Analysis 5.1

Data and Method

Since the structure of the United States financial system is projected on those of other countries around the world including those of member countries of the Islamic Development Bank (IsDB), it seems reasonable to assume that similar patterns are present in other financial systems. However, since most of IsDB members are developing economies the scope and extent of those problems might be different. At early stages of economic development when financial markets are not fully operational and credits are not available to most of the population introduction of Islamic financial services might mean additional credit to the consumers which is scarce even in the conventional non-Islamic form. At those levels, efficiency gained from more productive and socially useful allocation of capital may exceed the negative effects of increased transaction costs generated by financialization such that the overall effect might be reducing income inequality. We follow the approach of Sturm and De Haan (2017) in selecting the dependent variable measuring income inequality and use their data to construct a data set for our study. Our dependent variable is the Gini coefficient based on households’ income from Solt (2009) Standardized World Income Inequality Database (SWIID). Specifically we use the version of GINI coefficient calculated based on household’s income before taxes, to isolate the effect of income redistribution through the taxes done by the governments since it is difficult to control for heterogeneity of how successful governments are in that on the country levels. Delis et al. (2014) and Solt (2015) note that the SWIID database allows comparison across countries because it standardizes income. The Gini

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coefficient ranges from 0 (perfect equality) to 100 (perfect inequality). Other measures of income inequality, such as the share of income of the lowest quintile, have been used, but our study uses the GINI coefficient. Next we list all the variables used in our analysis presented in Table 1. We use a measure of financial development defined as private credit divided by GDP. That includes both credits given by conventional and Islamic banks. We also use a measure for financial sector liberalization, which was constructed by Abiad et al. (2010) and used by Sturm and De Haan (2017). It is based on seven indices of financial sector liberalization built a sum based on six of these. We also utilize a different measure constructed by summing four economic freedom sub-indices (3D, 4C, 4D, and 5A) from the Fraser Institute economic freedom database. Sturm and De Haan (2017) have more details on how this measure is constructed. We also employ the inflation rate and growth rate of GDP. Our measure of the credit loaned by Islamic financial institutions is derived from the Bankscope Data Base for the period from 2000 to 2012. The data set includes 14 countries, however, after merging two data sets the sample is reduced to only 8 countries because of missing data on gini coefficient values. The total credit loaned by Islamic banks is calculated at the country level as the sum of all credits given by all Islamic banks in the country. Finally, we divide these measures by the country’s total population to find the value of Islamic credit per capita. First, we estimate Table 1 2018) Region

Breakdown of the global IFSI by sector and region (USD billion, Islamic Sukuk Outstanding Islamic Takaful Banking Funds Contributions Assets

Asia 266.1 GCC 704.8 MENA 540.2 (ex-GCC) Africa (ex-North 13.2 Africa) Others 47.1 Total 1571.3 Source IFSB Stability Report 2019

323.2 187.9 0.3

24.2 22.7 0.1

2.5

1.5

16.5 530.4

13.1 61.5

4.1 11.7 10.3 0.01 – 27.7

Total

Share %

617.6 28.2 927.1 42.3 550.9 25.1 17.2

0.8

76.7 3.5 2190 100.00

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Table 2

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Definition of variables used in the analysis

Variable Name

Definition

Gini_market domcredgdp finreform_corr ffw_avg grrgdp inflation icreditpc

Gini coefficient using (pre-tax, pre-transfer) household income Domestic credit to private sector (% of GDP) Financial liberalization: Abiad et al. index Average of EFW-areas 3D, 4C, 4D and 5A GDP growth (annual %) Inflation, consumer prices (annual %) Total of Credit given by Islamic Banks per capita

the fixed and random effects specifications of the following panel data model for the entire time period between 2000 and 2012: G I N I _M A R K E Tit = β0 + D O MC R E D P G D Pit β1 + F I N R E F O R M_C O R Rit β4 + F F W _AV G it β4 + G R RG D Pit β4 + I N F L AT I O Nit β5 + I C R E D I T PCit β6 + βi + εit . The results are given in Table 2. The most important result is that the credit per capita loaned by Islamic banks lowers income inequality. The point estimate is negative and statistically significant for both model specifications, however, because some of the included explanatory variables missing values, the results are based only on 5 countries and 30 observations. As a robustness check we estimate a random effect specification for the same period between 2000 and 2012, but with only one exogenous variable ICREDITPC. That increases the number of countries to 8 and the number of observations to 81 and the effect is still negative and significant. 5.2

Findings

Overall, ICREDITPC lowers income inequality, however, there is a great deal of heterogeneity when different Islamic banks at the country levels started giving loan. Table 3 presents a list of the bank together with the year in which the bank loaned its first credit. Starting in 2007 most of the Islamic banks in the list became operational. We run one more model specification restricting the sample to only 2007–2012 observations and

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Table 3

Gini and financial credit: Panel data estimates

Years

(Intercept) domcredgdp finreform_corr ffw_avg grrgdp inflation icreditpc Observations R-squared Number of Countries

2000–2012 Fixed Effects

2000–2012 Random Effects

2000–2012 Random Effects

2007–2012 Random Effects

27.47 (7.67) .079 (.042) .317 (.517) 1.024 (.339) −.073 (.066) −.030 (.031) −.047 (.008) 30 0.4341 5

19.83 (4.99)

40.65 (1.38)

39.32 (1.22)

−.045 (.022)

−.0012 (.0005)

.0006 (.0002)

30 0.7821 5

81 0.0983 8

32 0.3651 8

.063 (.035) 1.501 (.802) −.538 (.796) .293 (.171) .217 (.111)

including a single explanatory variable. The effect of ICREDITPC is positively consistent with the measure of Islamic credit increasing income inequality. This can potentially be explained by the fact that by 2007 Islamic finance became a real force in the financial markets and a possibility that Islamic banks started finding ways to create new financial products increasing transaction costs and leading to financialization. Perhaps, at the beginning credits were given to most productive and socially useful causes but as the consumer base of the banks increased that gave greater potentials for redistribution of wealth coming from financialization. However, this conclusion is just a potential hypothesis. In order to be able to answer such questions more detailed data are needed at the micro levels, and that would be an important topic for future research (Table 4).

Banks Faisal Islamic Bank of Egypt Al Baraka Bank Egypt SAE Islamic International Bank for Investment and Development Bank Mellat Bank Melli Iran Bank Saderat Iran Bank Tejarat Parsian Bank Bank Sepah Bank Maskan Bank Pasargad Bank Keshavarzi-Agricultural Bank of Iran Eghtesad Novin Bank PJSC-EN Bank Saman Bank Bank Refah Bank of Industry and Mine Export Development Bank of Iran Karafarin Bank Bank Sarmaye Parsian Bank Jordan Islamic Bank Islamic International Arab Bank Jordan Dubai Islamic Bank Affin Islamic Bank Berhad HSBC Amanah Malaysia Berhad Kuwait Finance House (Malaysia) Berhad EONCAP Islamic Bank Berhad Alliance Islamic Bank Berhad

Country

EGYPT

MALAYSIA

JORDAN

IRAN

Countries, banks, and first year of crediting

Table 4

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2000 2002 2012 2003 2002 2000 2000 2000 2000 2008 2010 2000 2009 2010 2000 2000 2000 2009 2007 2003 2000 2000 2000 2006 2008 2007 2006 2008

First Credit

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TURKEY

MAURITANIA PAKISTAN

Country

Table 4 First Credit 2007 2008 2008 2006 2007 2006 2005 2005 2006 2008 2008 2005 2000 2004 2006 2009 2000 2003 2006 2005 2006 2005 2006 2006 2012 2007 2005

Banks Al Rajhi Banking and Investment Corporation (Malaysia) Berhad Standard Chartered Saadiq Berhad OCBC Al-Amin Bank Berhad Asian Finance Bank Berhad AmIslamic Bank Berhad Bank Islam Malaysia Berhad Bank Muamalat Malaysia Berhad CIMB Islamic Bank Berhad Hong Leong Islamic Bank Berhad Maybank Islamic Berhad Public Islamic Bank Berhad RHB Islamic Bank Berhad Banque Al Wava Mauritanienne Islamique-BAMIS Meezan Bank Limited Albaraka Bank (Pakistan) Limited BankIslami Pakistan Limited Dubai Islamic Bank Pakistan Limited Albaraka Islamic Bank BSC (EC)—Pakistan Branches Burj Bank Limited Standard Chartered Modaraba First Habib Modaraba First National Bank Modaraba Turkiye Finans Katilim Bankasi AS Albaraka Turk Participation Bank-Albaraka Turk Katilim Bankasi AS Ihlas Finans Kurumu A.S. Asya Katilim Bankasi AS-Bank Asya Kuveyt Turk Katilim Bankasi A.S.-Kuwait Turkish Participation Bank Inc

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Conclusion

Islamic finance has become the mainstream system of financial intermediation; started with the aim to provide social justice, equal distribution of resources, and uplift the less privileged segment of the society. However, over the last decade, Islamic finance is heavily criticized on the ground that it has converged to conventional finance and fail to play its part in achieving Maqasid-ul-Sharia. In this study, we investigate empirically whether Islamic finance has contributed to mitigate income inequalities. Data limitation prevents us from conducting comprehensive analysis for all countries where Islamic Finance has become an important part of financial markets. Nevertheless, we find that the available data have an important structural break at year 2007 when Islamic credits become more sizable. We find empirical evidence that expansion of Islamic credit, given to consumers, increases income inequality for the period of 2007– 2012. The result of this study suggests that theory and practice of Islamic finance is not consistent and diverging from the theme of Islamic economic system. The regulators, policymakers, and Sharia advisors need to holistically control and monitor the current practices of modern Islamic financial institution and reform the existing policies in the light of Islamic economic theory. Acknowledgements We thank Jan-Egbert Sturm for providing us with the data set and derivation programs used in Sturm and De Haan (2017).

References Abiad, A., Detragiache, E., & Tressel, T. (2010). A new database of financial reforms. IMF Staff Paper No. 57 , 281–302. Ahmed, H. (2005). Operational Structure for Islamic Equity Finance: Lessons from Venture Capital Research Paper No. 69. Islamic Research and Training Institute, Islamic Development Bank. Bakar, M. D. (2016). Shariah minds in Islamic finance. Amanie Media. Bolton, P., Santos, T., & Scheinkman, J. A. (2016). Cream-skimming in financial markets. The Journal of Finance, 71(2), 709–736. Cashin, P., Mohaddes, K., & Raissi, M. (forthcoming). A global model of MENA business cycles. Unpublished manuscript, International Monetary Fund. Chachi, A. (2005). Origin and development of commercial and Islamic banking operations. Journal of King Abdul Aziz, 18(2), 3–25.

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Chapra, U., & Khan, T. (2000). Regulation and supervision of Islamic banks. Occasional Paper No. 3. Jeddah: Islamic Research and Training Institute, Islamic Development Bank. Delis, M. D., Hasan, I., & Kazakis, P. (2014). Bank regulations and income inequality: Empirical evidence. Review of Finance, 18, 1811–1846. Deutsche Bank. (2007). Pioneering innovative Shari’a Compliant Solutions. Academic Paper. El Gamal, M. A. (2000). The economics of 21st century Islamic Jurisprudence. In Proceedings of the Fourth Harvard University Forum on Islamic Finance: Islamic Finance: The Task Ahead. Harvard University. Epstein, G. (2005). Financialization and the world economy. Edward Elgar. Haneef, R. (2005). Recent trends and innovations on Islamic debt securities: Prospects for Islamic profit and loss sharing securities. In S. Nazim Ali (Ed.), Islamic finance: Current legal and regulatory issues. Islamic Finance Project. Heck, G. W. (2006). Charlemagne, Muhammad, and the Arab Roots of capitalism. Walter de Gruyter. IMF Country Report No. 12/272, September. (2012). Iqbal, M., & Molyneux, P. (2005). Thirty years of Islamic banking: History, performance and prospects. Palgrave Macmillan. IRTI, Islamic Social Finance Report. (2014). Islamic Research and Training Institute. Islamic Financial Services Board. (2019). Islamic financial services industry stability report. Kuala Lumpur. Izhar, H. (2010). Identifying operational risk exposures in Islamic banking. Kyoto Bulletin of Islamic Area Studies, 3–2(2010), 17–53. Izhar, H., Rehman, Y., & Abdulmanap, T. (2018). Islamic finance in a global economic context. In Global Islamic Finance Report. Palley, T. (2007). Financialization: What it is and why it matters. The Levy Economics Institute. Philippon, T. (2012). Finance vs. Walmart: Why are financial services so expensive? In A. Blinder, A. Lo, & R. Solow (Eds.), Rethinking the financial crisis (pp. 235–246). Russell Sage. Philippon, T., & Reshef, A. (2012). Wages and human capital in the US finance industry: 1909–2006. The Quarterly Journal of Economics, 127 (4), 1551–1609. Piketty, T., Saez, E., & Zucman, G. (2018). Distributional national accounts: Methods and estimates for the United States. Quarterly Journal of Economics, 133(2), 553. Solt, F. (2009). Standardizing the world income inequality database. Social Science Quarterly, 90, 231–242. Solt, F. (2015). On the assessment and use of cross-national income inequality datasets. Journal of Economic Inequality, 13, 683–691.

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Stiglitz, J. E. (2012). The price of inequality: How today’s divided society endangers our future. W. W. Norton. Stiglitz, J. E. (2015). Rewriting the rules of the American economy: An agenda for growth and shared prosperity. W. W. Norton. Sturm, J.-E., & de Haan, J. (2017). Finance and income inequality: A review and new evidence. European Journal of Political Economy, 50, 171–195. Thomas, A., & Adam, N. J. (2004). Islamic bonds: Your guide to issuing, structuring and investing in Sukuk. Euromoney. World Bank. (2016). Poverty and shared prosperity 2016: Taking on inequality. World Bank Group.

CHAPTER 8

The Role of Islamic Financial System in Building Sustainable Infrastructure Zahid ur Rehman Khokher

1

Introduction

Infrastructure refers to services and systems that are crucial for the effective operation of a community, society or country and which help to maintain and enhance the productivity of its public, businesses and other prolific sectors (Ahmed, 2019; Mushtaq & Abdullah, 2018). In most cases, infrastructure is not involved in productive processes directly; however, it facilities the production of goods and services or provides the foundation on which primary agents in the economy (individuals and businesses) can play their role more effectively. Taking the agriculture sector as an example, in order for it to perform its adequate role in the economy, a number of support systems should be present: There should be appropriate education and health facilities for the individuals and their families working in this sector; irrigation facilities to water the crops; roads and transport to facilitate the movement of produce to nearby markets; electricity and fuel to water the crops and run the machinery and lit the households; and telecommunications to access the information,

Z. ur R. Khokher (B) Islamic Banking Department, Central Bank of Oman, Muscat, Oman © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8_8

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communicate with others and know about the forecasted weather conditions (Biancone & Radwan, 2018; Mushtaq & Abdullah, 2018). Similar example can be given for industrial production in an economy where a combination of education and health facilities, roads, transportation, telecommunication, power and gas, mining, training and development as well as ports and airports provide an ecosystem in which an industry will function and flourish (Obaidullah & Shirazi, 2014). Shortcomings in any of these components, on the other hand, could prove to be a stumbling block in the smooth functioning of economic sectors which can hamper or slow down the economic progress of a country. Infrastructure draws societal benefits which can be both direct and indirect. Not only infrastructure is a conduit of mobility and business, it also provides a skeleton in which various functions of economic and social life in a society are performed. Thus, development of infrastructure has both social and economic dimension (Woetzel et al., 2017). Similarly, infrastructure has direct and profound impact on the quality of life and overall economic development (Oxford Economics, 2017). In addition (Wan & Zhang, 2017) cite several benefits for firm productivity, reduction of transaction cost for businesses and consumers, easier access to markets and broadening of labour markets leading to boost in employment. Both developed and developing economies benefit from investment in infrastructure. The transformation brought by new infrastructure in developing countries and emerging markets could be highly impactful. Availability of clean water, better schooling and public health facilities, coupled with building of roads, provision of utilities and improvement in telecommunication facilities can make a marked difference in the livelihood and wellbeing of people in a country. Sustained improvement in these and other dimensions of infrastructure has proven to be closely linked to economic development (The World Bank, 1994). Not only amount of infrastructure is found to be directly proportional to a country’s income, it has been estimated that 1% increase in available infrastructure in a country helps boost 1% gross domestic product (GDP) in both developing and developed markets (Ahmed, 2019; The World Bank, 1994). Similarly (Ahmed, 2019) quotes several studies which showed that marginal increase in quantity and quality of infrastructure in Latin American, ASEAN and African countries to match the best performers in the respective region would augment long-term annual percapita GDP by a minimum of 1.1, 3.2 and 2.2%, respectively. In addition, improvement in stock of infrastructure assets is shown to have noticeable

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impact on the reduction of poverty, income inequality (measured as Gini coefficient) and social cohesion (ADB, 2017; Oxford Economics, 2015; Woetzel et al., 2017). In advanced economies, despite the fact that basic infrastructure is already available, new investments in other types of infrastructure investment such as clean energy, transportation, technology and telecommunications are considered vital for achieving sustained economic growth and reduce external shocks (Obaidullah, 2018; Oxford Economics, 2017; The World Bank, 1994). Similarly, it is argued that in the early stage of development, social infrastructure such as clean water, health and education creates greater impact whereas economic infrastructure takes a lead in the advanced development stage (Obaidullah & Shirazi, 2017; The World Bank, 1994). Another positive impact of infrastructure development on economic growth—which applies to both advanced and developing countries—is the higher productivity gains. Similarly, due to large sums of funding involved, improving the efficiency of infrastructure projects can result in cost saving and productive efficiency within infrastructure sector as well as reduced production costs in non-infrastructure related sectors that benefit from the building of infrastructure. Inter-American Development Bank (IADB) estimates that a 5% improvement in efficiency indicator in infrastructure projects could yield between 3.6 and 5% incremental growth over a 10-year horizon (IADB, 2018). The key factors for achieving such efficiency include improving governance, easing regulatory barriers, higher technological adoption and enhancing service quality. As important as infrastructure is to the economic and social development of human societies, an increasing attention is being given to the building of quality, sustainable and resilient infrastructure, as emphasized by several United Nations Sustainable Development Goals (SDGs) 2030 (Wan & Zhang, 2017). In order to build such infrastructure, Goal 17 of SDGs recognizes the role of domestic and international, public and private resources that require sufficient fiscal space and sound economic growth, supported by effective economic management, good governance, transparent procurement and project management systems (The World Bank, 1994). However, with an average infrastructure funding gap of over USD 2.6 trillion on an annual basis globally, the options to bridge this mammoth funding gap are being increasingly deliberated globally.

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Islamic financial system—with its roots in the principles of risk and reward sharing, equity, fairness and no-exploitation of parties involved in a financial transaction—offers a viable source of sustainable finance for building the infrastructure in both Muslim-majority and Muslim-minority countries (Levy & Iqbal, 2018). This paper explores a range of financing and investment options available in the Islamic finance system to fund the building of sustainable infrastructure on a Shari’ah compliant basis. Accordingly, using an exploratory research design, primarily secondary resources have been used in this study such as literature research, case study review and analysis of stimulating examples from history and recent past. The remainder of this chapter is organized as follows: After highlighting some unique features of infrastructure projects and their financing arrangements, the notion of sustainability in the context of SDGs and specifically for infrastructure is investigated. It is followed by insights on the alternative ways for categorizing the infrastructure projects. The existing funding gap for infrastructure to meet the existing needs at the global, Asia and OIC level is deliberated in detail, followed by an overview of options available in conventional financial system to fund this gap. Afterwards, a historical perspective on infrastructure building in several past Muslim civilizations is provided, showing that a range of Shari’ah compliant options were used by Muslim rulers and other philanthropic people in those times. Subsequently, with a brief snapshot of present Islamic financial services industry, major existing and potential Shari’ah compliant options for building sustainable and reliable infrastructure have been illuminated, while highlighting recent examples and suggestions for reforms to make these tools more impactful, widely available and cost-efficient. Finally, before providing concluding remarks, an assessment is provided on the immediate impact of Covid-19 on the ongoing and future infrastructure projects and opportunities this crisis will bring for Islamic finance.

2 Characteristics of Infrastructure Projects and Financing Arrangements Investment in Infrastructure has some special characteristics which differentiate it from other type of investments. Some salient features of building infrastructure are summarized below:

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(a) Significant initial capital requirements Generally, substantially large initial outlay is needed to build infrastructure (Deloitte, 2020; FSB, 2018; IADB, 2018). Building a dam, power plant, airport or highway, for example, could involve billions of dollars of initial investment, with large sink cost, which is typically bigger in size and scale than most other type of outlays in corporate finance. Such huge initial investment requirements also make major infrastructure projects natural monopolies (Ahmed, 2019; FSB, 2018). (b) Great benefits, but many are indirect There are direct benefits of building infrastructure, most in the form of public good, but indirect benefits outweigh them most of the time (Sawada, 2019). Direct benefits of transport infrastructure, for example, involve offering enhanced connectivity, improved information, reduced logistics cost with better access to labour markets. Simultaneously, several indirect costs also accrue alongside, which could include productivity improvement as well as information and technology spillovers that help the firms and individuals in respective regions to provide cheaper products and improved services (Wan & Zhang, 2017). (c) Returns accrue over a long time period Returns in infrastructure projects are generally low, have a long lag time and could accrue over a period spanning several decades. Accordingly, cash flows in infrastructure projects are typically deferred and financing is amortized over a long time horizon (Ahmed, 2017; Deloitte, 2020). However, when projects get fully operational in later years, generally cash flows are regular and robust (FSB, 2018). (d) Relatively high default rate in the early years Many infrastructures are impacted by external social, political and administrative factors due to which many of them run into defaults in the initial few years (FSB, 2018). However, if they can survive these initial years, cash flows are generally stable and risk factor gets diminished in subsequent years (Kumar & Arora, 2019).

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(e) Non-recourse financing Contrary to other types of corporate finance transactions, infrastructures typically do not give fund providers any access to other assets of the sponsors. Accordingly, project cash flows are typically the primary source of recourse available to creditors and equity holders of infrastructure projects, though pledge of the original asset is generally part of the financing structure (McMillen, 2001). (f) Greater contractual rights and financial and operational control In order to compensate the fund providers for being not able to attach project sponsors’ assets for credit risk, they are offered better contractual rights, step-in covenants and control over financial and operational measures such as debt-to-service coverage, leverage and cashflow ratios (FSB, 2018; Woetzel et al., 2016). (g) Large Externalities—social, environmental and climate implications As mentioned in the previous section, infrastructure development plays enormous role in social and economic development of a society. Simultaneously, several adverse externalities dilute the overall positive impact (FSB, 2018). Some of these negative implications could include, among others, water and air pollution, congestion of transport and displacement of people. This has led to an increased focus of multilateral development banks (MDBs), governments and other agencies in undertaking a comprehensive assessment of an infrastructure project—covering externalities and ensuring not only the financial feasibility but also environmental, social and institutional sustainability (Logan et al., 2017; Obaidullah, 2018) [see next section for further details].

3 3.1

Sustainability and Infrastructure

Sustainability, Sustainable Development and SDGs 2030

The concept of sustainability has evolved over time, though its concept mainly emanates from the dictionary definition of “being capable of continued at a certain level”. The increase in population and undeterred depletion of national resources by humankind has deteriorated

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the ecological balance, which has negatively impacted the quality of life over time in most societies (Logan et al., 2017). Thus, sustainability has a future dimension where it is envisaged that ability of future generates to utilize the national resources and living on this planet is not harmed with the actions of the current generation. The notion of sustainability encompasses all processes and actions that influence the ecological balance and quality of human life such as exploitation of resources, investment and finance, technological advancements, access to essential services, wealth distribution and changes in institutional and governance structures (Woetzel et al., 2016). When “sustainability” is combined with the concept of “development”, this concept suggests that resource utilization for meeting the existing needs of human being and their societies should be undertaken without compromising the accessibility of future generations to access the same (Logan et al., 2017). Accordingly, UN World Commission on Environment and Development states “sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs”. Thus, it is presumed that since humans have finite resources, these should be utilized prudently and carefully with an eye on long-terms consequences for the future generations and the societies they will live in. United Nations’ 2030 Agenda for Sustainable Development was issued in 2015 after the conclusion of Millennium Development Goals (MDGs) the same year, which listed down 17 ambitious SDGs and 169 targets to “complete what MDGs did not achieve” (UN, 2015a). These goals and targets are aimed at comprehensive and sustained development of humankind with prudent use of planet’s resources by encompassing people, planet, prosperity and peace, through “revitalized global partnerships”. Overall, SDGs identify implementation mechanism, a system for continuous review and assessment on the progress achieved by each nation of the world. In addition, SDGs not only are universal and ambitious, they also aim to integrate development with sustainability by taking account of relevant international covenants for each goal (Sawada, 2019). These international conventions cover a broad range of area such as Universal Declaration of Human Rights, Declaration on Environment, World Summit on Sustainable Development and World Summit for Social Development; Conferences on Population and Development, Disaster Risk Management, Environment, Climate Change and Biodiversity. In meeting these universal commitments, SDGs follow the principle of “common but differentiated responsibilities”.

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Several SDGs mention the significant role of “quality, reliable, sustainable and resilient” infrastructure in achieving these goals and targets. Goal 9 specifically aims to build “resilient infrastructure” to promote “inclusive and sustainable industrialization and foster innovation”. Detailed targets of other SDGs also mention the role of rural infrastructure (Goal 2, target 2a), provision of infrastructure for the household and family (Goal 5, target 4), and investment in energy infrastructure for supplying modern and sustainable energy to all development countries (Goal 7, target 7b) (Oxford Economics, 2015; UN, 2015a). On overall basis, SDGs on good health (SDG 3), quality education (SDG 4), clean water and sanitation (SDG 6), affordable and clean energy (SDG 7), industry innovation and infrastructure (SDG 9), sustainable cities and communities (SDG 11) and climate action (SDG 13) can only be achieved if underlying infrastructure is made available to provide health, education, water management and clean energy, housing, while taking account of their impact on environment (ADB, 2017; Sawada, 2019). In terms of investment to build the infrastructure, Goal 17 of SDGs acknowledges the role of domestic and international finance, private sector and multinationals. However, SDG document places special role for international public finance where advanced economies provide “official development assistance” to generate additional resources (UN, 2015a). UN also issued another official document in 2015, called Addis Ababa Action Agenda, which outlines aspects of finance and investment needed to build the infrastructure for achieving SDGs by 2030 (UN, 2015b). It notes a global infrastructure gap of USD 1–1.5 trillion on an annual basis in developing countries. To bridge this gap, this document lists a host of international donors and multilateral development banks (MDBs) that can offer enhanced financial and technical support. However, Addis Ababa Agenda also acknowledges primary role of domestic public resources for building the infrastructure that can be generated by economic growth, facilitated by sound economic and social policies, good governance, sufficient fiscal space and transparency (Abdelkafi & Bedoui, 2016; Iqbal, 2019). Similarly, improvement in taxation regime and revenue collection can help create additional fiscal space. Similarly, international and public finance, both combined, also need additional support from domestic and international private finance, foreign direct investment, public–private partnership (PPP) and an active capital markets to raise funds (FSB, 2018; OECD, 2014).

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The Notion of Sustainability in Infrastructure

The notion of sustainability in infrastructure development is important from many perspectives. According to an estimate, 60% carbon emissions of the world are generated from the construction or the use of prevailing infrastructure stock. Similarly, it is estimated that an additional 35–60% carbon emissions in the future will be directly related to the infrastructure (Sawada, 2019). Most infrastructure projects are heavy users of fossil fuels both for building and running the operations. Similarly, due to large size and heavy investment involved, long-term nature of infrastructure projects has a an “inherent inertia” and “technological lock-in” due to which more efficient and greener technologies cannot be adopted easily after an infrastructure has been built and commissioned (IADB, 2018). More importantly, there are already estimates that target of Paris Agreement for keeping the increase in temperate below 2 degree centigrade cannot be achieved if power generation continues to rely heavily on fossil fuels. Infrastructure projects have several other externalities that impact negatively on human life, ecosystems, social harmony, gender diversity, distribution of wealth as well as financial health of municipalities, states and countries (IADB, 2018). Many projects are not financially viable, become white elephant and increase the debt burden for the public sector, as a result of which they find reduced fiscal space to provide other essential services to the communities and individuals (Khokher, 2019a). Many infrastructure investments are made for projects that have minimal benefits for local job creation or improved services, have little transparency and only marginal involvement of local communities which results in social conflicts. Financial and social problems also arise due to poor planning and consultation, minimal monitoring and corruption resulting in project delays, cost overruns and obstruction in daily lives of common people (IADB, 2018; Sierra et al., 2017). Resultantly, governments and other project sponsors get their reputation suffered which makes commencing new infrastructure projects cumbersome, lengthy and prone to legal challenges. Similarly, increasing voice of civil society, popularity of social media and better connectively through new technologies and mobile phones add to the complexity in building the infrastructure as problems and inefficiencies are highlighted and propagated rapidly. These considerations and complexities lead to the emphasis on “sustainable infrastructure” (ADB, 2017; Logan et al., 2017). Both World

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Bank (World Bank Group, 2008) and United Nations (UN, 2001) identify three common elements for building sustainable infrastructure: financial and economic sustainability, environmental sustainability and social sustainability. UN Framework and Inter-American Development Bank add a fourth dimension on institutional sustainability to ensure that framework and capacities are built at local, institutional level to design, construct and operate infrastructure over the entire life cycle of the project (IADB, 2018). The term “sustainable infrastructure” is sometimes interchangeably used with the terms “smart infrastructure’” or “green infrastructure”; however, the latter two terms only encompass a subset of environmental or economic sustainability and, in practical sense, are used more of a buzzword rather than conveying a well-defined term. Overall, key objectives of a sustainable infrastructure project are to: (i) offer affordable and high-quality service, (ii) assist inclusive growth and (iii) boost productivity, while considering social and environmental aspects (Logan et al., 2017). An explanation of these four dimensions is provided below: (a) Economic and Financial Sustainability There are two main components of this dimension: First, infrastructure project is able to produce a “positive net economic return” over the entire life cycle, while taking into account all the benefits and costs, spillovers and externalities—be they positive or negative. Second, for the investors, project should be able to generate a positive, adequate riskadjusted return. In order to achieve these two objectives, project might need support by carefully aimed subsidies to enhance affordability of the users and cater for spillover implications, if any (IADB, 2018; The World Bank, 1994). (b) Environmental and Climate Sustainability An environmentally sustainable infrastructure is expected to preserve and integrate natural ecosystems in such a way that it promotes sustainable utilization of natural resources and limits pollution (ADB, 2017). Similarly, environmentally sustainable project should be resilient to climate change and natural disaster risks (Logan et al., 2017; Obaidullah, 2018).

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(c) Social Sustainability Socially sustainable infrastructure projects should address three main considerations: First, project should have wider support of target population and contribute to their improved livelihood over the lifetime; Second, project must follow global standards for health, labour rights and safety during the construction and operation phase; Third, project should allocate its benefits in an equitable and transparent manner to the ultimate beneficiaries, so that human rights, gender equity, labour protection and well-being of the communities is preserved and protected (IADB, 2018; Sierra et al., 2017). In addition, since many major infrastructure projects involve resettlement of communities, project sponsors should avoid displacement to the maximum possible extent. If avoiding displacement is not entirely possible, then affected persons and families should be appropriately consulted, compensated and relocated to the most suitable alternatives, while preserving culture and heritage as far as possible (Sierra et al., 2017). (d) Institutional Sustainability Institutional sustainability in infrastructure projects aims to achieve four main objectives: First, procedures for planning, design, procurement and operation of projects should be clearly laid out; Second, Transparent, robust and uniform governance system be adopted in all phases of project life cycle, to minimize corruption, spillovers and social disharmony. Third, local capacity to run the project and stimulate systemic change for relevant communities should be built by employing transfer of technical knowledge, training for project management and prompting innovative thinking. Fourth, post implementation, project should develop an integrated and reliable system for the collection of data, monitoring of impact and evaluation of results to produce empirical evidence that can be used for building similar projects and avoiding the pitfalls for the future (IADB, 2018) (Fig. 1).

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Economic and Financial Sustainability

Environmental and Climate Sustainability

• PosiƟve net economic return over the project life cycle • Adequate risk-adjusted return for investors

• Preserve and integrate natural ecosystems • Sustainable use of natural resources and limit polluƟon • Resilient to climate change and natural disaster risk

Social Sustainability

InsƟtuƟonal Sustainability

• Wider support & improved livelihood of target communiƟes • Follow global standards on health, labor rights & safety • Allocate project benefits in equitable & transparent manner • Displacement to be minimised, consulted and adequately compensated

• Clearly laid out procedures of planning and operaƟon • Transparent and robust governannce system • Building of local capacity by knowledge transfer & training • Data collecƟon for impact monitoring

Components of sustainable infrastructure (Source Author)

4 Infrastructure Categorization, Investment Needs and Funding Gaps 4.1

Categorization of Infrastructure

Since infrastructure projects cover a wide range of sectors, they can be categorized in many different ways: initial investment need, useful life, number of beneficiaries, public or privately funded, environmental impact and social benefits. For the purpose of this paper, nevertheless, we focus on classification suggested by (OECD, 2014) that looks at the financial sustainability of infrastructure projects.

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First category of projects offers net positive financial risk-adjusted return over the life of the project, including regular profits. Thus, such projects can be considered “fully sustainable projects” since their revenue streams alone are sufficient to generate adequate returns. The examples are energy and power; road and highways; telecommunications, etc. Second category of projects is “partially self-sustainable” since the prices set on these services alone are not able to generate sufficient return to the project sponsors. Usually, these projects are controlled by the government and considered “public good”, due to which government does not charge the services at sufficient level to cover the project cost and generate profits. However, to compensate the private sector investors, such infrastructure projects are given tax breaks, subsidies and grants (FSB, 2018; The World Bank, 1994). The examples are water and sewerage, railways, urban metros and light rail. Third type of infrastructure projects generate negligible revenue streams, which, at maximum, could cover only a fraction of investment made for building and operating the infrastructure. Such projects are part of social infrastructure of a country and private sector usually has minimal participation in such projects (Abdelkafi & Bedoui, 2016). These projects include public housing, public sector hospitals, schools, technical training institutes and libraries (Khokher, 2019a). 4.2

Investment Needs and Funding for Building Sustainable Infrastructure

At the Global and Regional Level Since the launch of SDG framework in 2015, various estimates have been published for building the required infrastructure to meet SDG requirements at the global and regional level. While partially, these estimates represent the definition of infrastructure itself and the sectors included, with the passage of time these estimates also change with developing economic conditions and assumptions related to GDP growth, fiscal discipline, changes in demographic conditions (such as population growth, urbanization) at the jurisdiction level (Khokher, 2019a; Oxford Economics, 2017). An estimate by (Ahmed, 2019) suggests a sustainable infrastructure gap of USD 93 trillion between 2016 and 2030. According to this estimate, energy, transport, water and sewerage and telecom contribute to 43, 29, 20.4 and 7.5% of the total, respectively. Depending on the growth

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forecast assumption of high to low, the funding gap ranged between USD 39–51 trillion, on an average of USD 2.6–3.4 trillion per year. Another detailed study commissioned by G-20 in 2017 estimated global infrastructure investment needs for six sectors—road, electricity, rail, telecommunications, airport and port—to be USD 3.8 trillion by 2040. However, if countries wish to match the best performers in their region, they will need USD 4.6 trillion for these sectors. In addition, G-20 has established an interactive tool, called Global Infrastructure Outlook (https://outlook.gihub.org), which provides jurisdiction-level, regional and global data for current investment in sustainable infrastructure, future needs and infrastructure gap. According to this data, future investment need in sustainable infrastructure will be highest in transportation (37% share in global infrastructure investment) and energy (30%), followed by rail (12%), telecoms (9%) and water (7%) (Oxford Economics, 2015, 2017) Similarly (Abdelkafi & Bedoui, 2016; Woetzel et al., 2017) estimated that every year, USD 3.7 trillion of investment will be needed in building infrastructure until 2035 to match projected GDP growth in the world with average needs for power and roads with 1.3 and 1.0% of GDP. For Asia, Asian Development Bank estimated that to meet SDG targets by 2030, developing Asia will need investment of USD 22.5 trillion or USD 1.5 trillion a year, which is equivalent to 5.1% of expected GDP of the region (Sawada, 2019; ADB, 2017). However, if climate change is factored in in the baseline scenario, the estimate increases to USD 26.2 trillion, corresponding to USD 1.7 trillion a year (5.9% of expected GDP) (ADB, 2017; Sawada, 2019). This additional investment will be needed to limit rise in surface temperature below 2 °C, which requires investment in renewable energy as well as efficiency in energy transmission and storage by using smart grids, etc. (Ra & Li, 2018). Similarly, for Africa, infrastructure investment need is estimated to be over USD 93 billion annually, with a financing gap of over USD 50 billion (The World Bank, 2017). For Latin America, annual infrastructure gap is estimated to be in the range of US$120–150 billion to meet SDG objectives (IADB, 2018).

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5

Financing the Sustainable Infrastructure---Investment Options in Conventional Finance Due to their enormous size and complexity, most infrastructure projects usually involve complex suite of contracts and varied stakeholders in three main phases of infrastructure development viz: planning, construction and operation (FSB, 2018). During each phase, different set of financial arrangements may be involved. For example, during planning stage, equity has to be arranged by public sector from its own or international sources, which is supplemented by debt. Debt providers usually require higher expected returns for providing funding at this stage due to long period involved. Construction stage is considered most risky, which is exacerbated by the size and complexity of the project. Funding for this stage is commonly undertaken by a combination of equity and debt raised in the previous stage. However, in case of cost overruns, more equity or debt has to be arranged by the project sponsors. Operational stage primarily involves cash flow risk as default risk diminishes after the construction phase. Any revenue shortfalls may require refinancing of debt directly by government, tapping the capital market for bond issuance or seeking loans from commercial banks (Ahmed et al., 2015). In the conventional environment, investment sources for sustainable infrastructure can be either domestic or international. Similarly, funds can be sourced from public or private sectors. Looking at these two dimensions simultaneously reveals a host of financing options at the domestic level such as: allocation in government budget (funded by tax revenue or duties), public sector borrowing from banks or accessing capital market, investment by domestic state owned enterprises (SOEs) or governmentlinked companies (GLCs), private sector, financing by domestic banks or non-bank financial institutions (insurance companies, mutual funds, private equity firms, pension funds, development banks), investment by non-government organizations as well as philanthropic contributions by corporate sector or individuals (FSB, 2018; OECD, 2014). At the international level, funding can be provided by multilateral development banks (MDBs), official development assistance by governments, sovereign wealth funds, foreign direct investment by public or private/corporate sector, international infrastructure funds as well as financing by large commercial banks or other financial institutions (OECD, 2014). Similarly,

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funding, mostly in the form of debt, could be raised by project sponsors (public or private sector) in the international capital markets. Apart from direct funding by private equity firms, private sector financial institutions, or individuals, private sector participation in infrastructure projects is usually undertaken through public–private partnership (PPP; Abdelkafi & Bedoui, 2016). Under PPP arrangement, contrary to direct financing of the project by the public sector, the “ownership of a public asset” is transferred to the private sector for a defined period of time, through a mechanism called “concessional arrangement”. This arrangement outlines the roles of both public and private sector entities in the project, while defining the control and ownership rights of each during the project period (OECD, 2014). As expected, most projects qualifying for PPP arrangements are those which have net positive economic returns over the life cycle of the project with a relatively stable revenue stream such as energy, power generation, highways and ports, etc. However, there is always a risk that a PPP project can go wrong and result into massive waste of money due to non-consideration of sustainability dimensions discussed in Sect. 3.2 (Woetzel et al., 2016). Section 3 explicated the aspects of sustainability now being considered by many investors of infrastructure, which goes beyond the economic and financial sustainability and incudes environmental, social and institutional sustainability. Similarly, an increasing awareness at global level can be witnessed for environmental, social and governance (ESG) assessment of infrastructure projects (Deloitte, 2018). Similarly, socially responsible investment (SRI), responsible and ethical finance is taking root in many sectors and industries, including when funding infrastructure projects (Obaidullah, 2018; Zeti Akhtar Aziz et al., 2019). However, in order to build an ecosystem for the sustainable infrastructure development, reforms and sustained participation is needed from the governments to facilitate required adjustments in legal and regulatory framework for infrastructure projects, bring improvements in project selection and evaluation criteria and implement enhanced disclosure and transparency in line with good governance principles (Woetzel et al., 2016).

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6 Investment in Sustainable Infrastructure Through Islamic Finance 6.1

Building and Funding the Infrastructure in Muslim Civilization

Before discussing the financing of infrastructure development through Islamic finance, it is pertinent to investigate how the infrastructure projects had been funded by Muslim rulers in last one and half millennium. This review will also shed light on the tools that have been traditionally used to finance the building and operations of those facilities. History of Muslim civilization shows that state funding and awqaf (singular:waqf) were most prominent sources of infrastructure development and operations (Lahsen & Raghibi, 2018) which include, among others, mosques, healthcare, education, water, sanitation and other social causes. One of the first known projects from the life of Prophet Muhammad (peace be upon him) is a well that was purchased by Uthman bin Affan (may Allah be pleased with him) from a Jewish person, which he dedicated for supplying free water to all (Obaidullah & Shirazi, 2014). This role of state and waqf continued to expand in Umayyad and Abbasid period (Lahsen & Raghibi, 2018; Renima, 2016). In the eighth century, Zubaydah bint Jafar, who was the wife of one of the most well-known Abbasid rulers, Harun Al-Rashid, rebuilt the centuries-old pilgrimage road which ran from Kufa in Iraq to Makkah in Hejaz. This pilgrimage road, later known as Darb Zubaydha, not only facilitated the religious travel, but also became a hub of trade and commercial links (UNESCO, 2019). Similarly, this travel route was integrated with canals, pools, wells and water reservoirs which showed architectural ingenuity of the builders and a carefully planned sustainable investment to run the infrastructure through philanthropic work (Renima, 2016). In Europe, tenth century Al-Andalus had the best infrastructure in the world (Renima, 2016). Apart from numerous free schools, a magnificent library with more than 400,000 volumes and a grand mosque, the city of Cordoba had over 16 kilometers of paved roads, which were lighted every night, were all funded by the state or awqaf. Later, throughout the Ottoman empire, especially between sixteenth to eighteenth centuries, waqf establishments got prominence, which were used to fund the building and running of bridges, hospitals, schools, universities, mosques, fountains and dervish-convents (Inalcik, 1969; Lahsen

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& Raghibi, 2018). Waqf has generally two set of establishments: first was to run these institutions and second was to make investments “in a true spirit of economic enterprise” to generate profits through agriculture activity, trade and other forms of business (Abdullah, 2018; Inalcik, 1969). (Gaudiosi, 1988) even attributes the establishment of Merton College at Oxford University in 1274 through “a simple, unincorporated charitable trust, markedly similar to the Islamic waqf”. At the state level, Ottoman rulers also constructed their landmark Hejaz railway which commenced operations from Damascus to Madinah in 1908, with a branch line to Haifa on the Mediterranean Sea (Alshehri, 2018). This four million lira project was funded from several sources: state budget, loan from banks such as Ziraat Bankasi and donation from public administrated by Donation Commission (Alshehri, 2018). (Lahsen & Raghibi, 2018) observed that at the end of Ottoman empire in 1923, 75% of agriculture land in Turkey, about 12 and 15% cultivated land in Egypt and Iran respectively were part of waqf. This ratio was even higher in North African territories where in late nineteenth century, about 50% of cultivated land in Algeria and 33% in Tunisia was managed by awqaf. Similarly (Savage-Smith, 2019) tracks the history of building hospitals in the Muslim lands over a span of over a thousand years, from ninth century onwards. The study records that almost all the hospitals in Muslim empires were funded by awqaf, the properties of which were donated by affluent people as endowments. These properties not only helped fund social and entrepreneurial projects such as mills, caravanserais and shops but also to run the entire villages and settlements. Nevertheless, sometimes running of these properties were partially funded by the state (Abdullah, 2018; Hassan et al., 2019; Lahsen & Raghibi, 2018; Savage-Smith, 2019). The case of Mughal empire in sub-continent was no different where landmark buildings, masjids and mausoleums had vast properties that were either state owned or run by awqaf (Mohsin et al., 2016). Famous landmark Taj Mahal was built by Mughal emperor Shah Jahan in the memory of his loving wife Mumtaz Mahal, which was administered as a waqf, that included accompanying Moti Masjid and other establishments.

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State of Islamic Financial Services Industry

Contemporary Islamic financial services industry can trace its roots to early experiments in three parts of the world: In Egypt, the establishment of saving and investment cooperative in Mit Ghamar in 1963; In the Philippines, initiation of public sector Amanah Bank in 1973 to offer commercial and investment banking services as per Islamic principles and start of Dubai Islamic Bank in United Arab Emirates (UAE) in 1975. Multilateral institution, Islamic Development Bank (IDB) was also established in Jeddah in 1975. Similarly, two Islamic insurance (takaful) companies were established in the Arab world, namely, Islamic Insurance Company in Sudan and Islamic Arab Insurance Company (known as Salama) in UAE in late 1970s. Since then, Islamic finance industry has expanded into most segments of financial sector including investment banking, retakaful firms, mutual funds, private equity, Mudarabah companies, venture capital, pawn shops, equity and indices, hedging, hedge funds, corporate and sovereign sukuk, infrastructure fund and project finance, microfinance, microtakaful, leasing companies, real estate investment trust, crowdfunding platforms, wealth funds, waqf as well as retail, social and green Sukuk (Deloitte, 2018; Sidlo, 2017) It could be noted from the list that entire spectrum of financial sector products is now available by Islamic financial sector and all stakeholders of financial sectors—governments, government-linked companies, corporate sector, individuals—can find a product or service to meet their saving, financing and investment needs. The overall size of three main sectors of Islamic finance industry— banking, takaful and capital market—at the end of year 2019 is estimated to be USD 2.44 trillion (IFSB, 2020). According to this report, the share of Islamic banking assets, sukuk outstanding, Islamic funds’ assets and takaful contributions constituted USD 1765.8 billion (72.4% of total industry), USD 543.4 billion (22.3%), USD 102.3 billion (4.2%) and USD 27.07 (1.1%). Out of these sectors, Islamic capital market (at 26.5% total industry) has gained share from Islamic banking sector in past few years. Over a decade ago, Islamic banking segment used to be around 80% of the total sector which has now declined to 72.4%. In terms of regional distribution, the share of six Gulf Cooperation Council counties is largest, constituting 45.4% of the total industry, followed by Middle East and South Asia (25.9%), South East Asia (23.5%), Africa (1.6%) and remaining regions (3.7%) (IFSB, 2020).

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Islamic finance sector, despite being available in over 70 countries, remains concentrated in about 15–20 jurisdictions, out of total 57 OIC countries. A total of 13 countries are considered to have systemically important Islamic banking industry as market share of this sector is more than 15% of the total banking sectors. There are countries—namely, in order of market Islamic banking market share: Iran, Sudan, Brunei, Saudi Arabia, Kuwait, Malaysia, Qatar, Bangladesh, Djibouti, UAE, Jordan, Palestine and Bahrain—constitute 91.4% of entire Islamic banking assets and 83.3% of sukuk outstanding at the global level. Pakistan and Oman are close to 15% Islamic banking market share threshold and if their Islamic banking assets are included, these 15 counties combined constitute 93.2% of global Islamic banking (IFSB, 2020). This analysis shows that there is still a wide room for the expansion of Islamic banking sector in OIC countries and beyond.

7 Shari’ah Compliant Options to Build Sustainable Infrastructure Following the above snapshot of Islamic financial services industry, we explore major Shari’ah compliant options that can be tapped by governments, private sector and even individuals for building infrastructure. Considering the limitations faced due to Shari’ah limitations of the type of debt which can be raised, it will be shown that Islamic finance offers several additional options for building the social infrastructure which are typically unavailable to non-Muslims such as waqf and zakah. 7.1

Government

Previous section on infrastructure in Muslim civilization confirms that historically, governments and rulers have been the primary source of planning, building and operating various types of infrastructure throughout various Muslim lands, some of them exist to date. Coupled with Islamic social finance tools and philanthropic activities, an entire spectrum of options was available to meet the needs of previous generations. With the passage of time, the needs of societies for sustainable infrastructure have amplified and many projects require huge volume of funds and advanced technical capabilities to plan, build and sustainably operate such projects, which are still available with public or multilateral sector.

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Most developing countries, including OIC, are facing huge budget deficits as well as significant domestic and external debt which results in the transfer of sizeable portion of their revenues in servicing the debt (for payment of interest and principal). As an example, the following is the debt service ratio of selective OIC countries from World Bank Development Indicators (WDI) that measures the amount of interest payment for debt to export earning of a country. As a rule of thumb, a ratio more than 20% is a sign of impending economic crisis. Lebanon (72.1%, 2018), Djibouti (57.8%, 2017), Kazakhstan (48.3%, 2018) and Turkey (36.7%, 2018). Looking from another perspective, interest expense as a percentage of revenue for some OIC countries such as Lebanon (50%, 2018), Pakistan (40.2%, 2019), Egypt (33.3%, 2015) and Bangladesh (18.5%, 2016) shows an alarming situation [WDI]. Principally, governments have several alternate sources for funding the infrastructure that includes annual development budgets—that rely on revenues such as taxes, duties and tolls—national resources concessions and infrastructure user fees (IADB, 2018)(Abdelkafi & Bedoui, 2016). Additionally, governments can raise funds from international donors called Official Development Assistance programmes by advanced economies, borrowing from MDBs, accessing international development assistance by organizations such as United Nations Development Programme (UNDP), accessing international or domestic capital markets by issuing bonds/Sukuk, involving private sector through PPP projects or simply appealing to the public to “crowdfund” the infrastructure projects (Ahmed et al., 2015; FSB, 2018; OECD, 2014). Unfortunately, except a few countries such as Malaysia and Indonesia to a limited extent, not many government in the OIC have a declared plan to fund—fully or partially—their annual or medium-term infrastructure development programme through Shari’ah compliant sources (Iqbal, 2019). 7.2

Government Linked Companies and State-Owned Enterprises

Apart from governments, in several jurisdictions, SOEs and GLCs have been actively using Shari’ah compliant means to raise their funds. These companies mostly operate in utilities, energy and power, telecommunications, civil aviation and electricity distribution sectors (Biancone & Radwan, 2018). In addition, in certain cases, some state sponsored Shari’ah compliant investment companies and funds have funded the

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infrastructure projects (Levy & Iqbal, 2018). Moreover, some GLCs have provided guarantee or advisory support for building the infrastructure projects (Abdelkafi & Bedoui, 2016). GLCs in Saudi Arabia have used Shari’ah compliant project finance quite extensively in past two decades (Malikov, 2017). One of the earlier such projects was a joint Aramco-Sumitomo Chemical of Japan refinery and petrochemical complex worth USD 9.9 billion, for which an Islamic tranche of USD 600 million was raised in 2006 through a consortium of Islamic Development Bank and several commercial and investment banks in the region (Nethercott et al., 2006). Similarly (McMillen, 2001) cites examples of financing Saudi Chevron Petrochemical Project and SCECO Power Project in Saudi Arabia that were partially funded through consortium of banks and multilaterals. In last decade, Saudi Electricity Company, Saudi Arabian Mining Company and General Authority of Civil Aviation have raised billions of dollars through sukuk to fund their infrastructure developments (IIFM, 2014, 2017, 2019; Malikov, 2017). Furthermore, GLCs are active in many other jurisdictions to raise funds through Shari’ah compliant means, primarily issuing Sukuk. Some examples are Pakistan: Pakistan Mobile Communication Limited, Water and Power Development Authority, Neelum Jhelum Hydropower Co. Ltd; Malaysia: Petroliam Nasional Berhad, Celcom Transmission, Expressway Lingkaran, Sarawak Energy, Khazanah Nasional Berhad, New Pantai Expressway, Projek Lebuhraya Utara-Selatan, Tenaga Nasional Berhad, Danalnfra Berhad; UAE: Dubai Electricity and Water Authority, DP World, Emirates, FlyDubai, Jebel Ali Free Zone; Indonesia: Garuda Indonesia, National Electric Company (IFSB, 2018; IIFM, 2016, 2019; Malikov, 2017). Nevertheless, such raising of funds through Shari’ah compliant means by GLCs or other large corporates have not been used beyond a dozen or so jurisdictions (IDB-IRTI-IFSB, 2014; IFSB, 2018). To incentivize the utilization, not only governments and GLCs need a commitment at Ministry of Finance (MoF)/board level to tap part of their funding through Islamic finance, but also necessary legal, regulatory and tax reforms have to be implemented (Iqbal & Khan, 2004). As an example (Khokher, 2019b) quotes Malaysia where government had granted tax breaks for issuing equity-based and Ijarah sukuk in 2000s. In addition, in several budgets, Malaysia gave concessions on stamp duty and profit received on foreign currency Sukuk. In 2016, Turkish government also granted tax and fee exemptions on the issuance of Shari’ah compliant

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lease certifications. In addition, Capital Market Board of Turkey offered 50% discount on the registration fee applicable on Sukuk (IIFM, 2019; UNDP, 2014). 7.3

Multilateral Development Institutions

MDBs are major providers of infrastructure finance at the global level (Kumar & Arora, 2019). Out of several international players, the operations of only one MDB, the IDB Group, are entirely Shari’ah compliant. The IDB, a triple-A rated entity, has 57 member countries mainly concentrated in Africa, Asia, Middle East and Europe. Taking benefit of its strong capital of USD 8 billion and impeccable rating, IDB is a regular issuer of international Sukuk in various currencies (US Dollar, Euro, Saudi Riyals and Malaysian Ringgit) in the range of USD 3–4 billion a year, which permits it to expand its coffer for financing the infrastructure and other projects in member jurisdictions. However, its balance sheet base of about USD 30 billion is sufficient to meet only a small portion of infrastructure needs of its member countries. With the introduction of its Sustainable Financing Framework, IDB’s project selection criteria includes multidimensional assessment of sustainability element, green and social project financing, in line with SDGs. Its green project category includes renewable energy and energy efficiency, clean transportation, sustainable water and wastewater management, etc. Similarly, its social project categories include employment generation, SME financing, affordable housing and basic infrastructure, socioeconomic advancement and empowerment. Similar approach is being taken by other IDB Group institutions such as Islamic Cooperation for the Development of private sector (ICD) for infrastructure support. IDB has also partnered with other MDBs such as Asian Development Bank (ADB) in 2009 to establish a USD 500 million Shari’ah Compliant Infrastructure Fund which aimed at making equity investments in 12 common member countries (Sidlo, 2017). Similarly, IDB has provided joint project financing with the Asian Infrastructure Investment Bank (AIIB). ADB has also been active in Islamic finance space since 2003 and has been undertaking a range of activities such as advisory, technical assistance to its member countries, supporting standard setters such as Islamic Financial Services Board (IFSB), issuing publications and building awareness on Islamic finance (Khokher & Ismail, 2015; Sidlo, 2017). On the

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financing side, in 2011, ADB approved a USD 60 million partial credit guarantee for the lease payment obligations of project companies to IDB in Pakistan. In 2012, ADB provided Agribusiness Development Assistance in Muslim majority island Mindanao, the Philippines to promote agri-business and introduce Islamic financing products.1 The World Bank is the biggest MDB in the world. During last two decades, it has been active in numerous Islamic finance related activities such as technical assistance; advisory services on strengthening legal and regulatory frameworks; awareness creation, publications, training, capacity building and development of Islamic capital markets (Ahmed et al., 2015; Iqbal, 2019; The World Bank, 2017). The World Bank has also coordinated with IDB on two joint initiatives named as Deep Dive Initiative and Arab Financing Facility for Infrastructure. The former, signed in Q3 of 2015, focused on development assistance in common member jurisdictions whereas the latter collaboration aimed specifically for the development of infrastructure in the Arabic speaking jurisdictions (Sidlo, 2017). However, as far as providing direct Shari’ah compliant financing for infrastructure projects is concerned, World Bank has taken only rudimentary steps. For example, it has provided Shari’ah compliant support in selective jurisdictions for initiatives related to small and medium enterprises (SMEs) involving credit lines in Turkey, guarantee programme in Palestine and Jordan as well as Islamic finance leasing in Egypt (Sidlo, 2017). World Bank’s affiliate International Financial Facility for Immunization has also raised funds through the issuance of Sukuk for the immunization of children in low income countries (Iqbal, 2019). In addition, World Bank’s private sector arm, the International Finance Corporation (IFC) as well as African Development Bank (AfDB) have hardly funded any major infrastructure through a Shari’ah compliant structure until now (AfDB, 2018). To resolve such dearth of Shari’ah compliant financing for sustainable infrastructure projects, several steps could be taken as outlined below: (a) IDB needs to enhance its capital base similar to what other MDBs have done in the last decade or so. In 2009, ADB tripled its capital from USD 55 billion to USD 165 billion. In 2017, it blended

1 https://www.adb.org/sectors/finance/islamic-finance/country-profiles.

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its financing through Asian Development Fund with its regular funding, which will permit it to finance projects of over USD 20 billion annually.2 Similarly, in October 2019, AfDB increased its capital from USD 93 billion to USD 208 billion.3 IDB, with a paid-up capital of merely USD 7.8 billion does not have capacity to meet the infrastructure funding gap and provide large scale funding as its peers are doing (IDB, 2019). (b) IDB can increase its co-funding with other MDBs as it has done with ADB in the past, either through the establishment of Islamic Infrastructure Funds or direct financing (Sidlo, 2017). Such collaboration will expand the outreach of its Shari’ah compliant funds globally and also resolve capacity constraints with other MDBs whose staff is not much familiar with the technicalities of Islamic project finance contracts and arrangements. (c) IDB can support the establishment of a new infrastructure-focused Shari’ah compliant international bank. Several attempts in this regard—some of which were sponsored by the IDB—have not borne any result in the past. For example, In April 2012, IDB announced the establishment of a Mega Islamic Bank for infrastructure funding with a capital of USD 1 billion that will be sponsored by Qatar, IDB and Dallah Al Baraka Group (IDB, 2012). Similar news of the establishment of a new Islamic Infrastructure Bank emerged in 2016 where Indonesia, Turkey and IDB agreed to establish such bank “within six months” (Hermansyah, 2016). However, no progress on the ground could be witnessed. Lately, in March 2019, State of Qatar announced the launch of a new energyfocused Islamic infrastructure bank with an initial capital of USD 10 billion for financing both domestic and international projects (Knecht & Azhar, 2019). However, until mid-2020, such bank has not been launched.

2 https://data.adb.org/dataset/general-capital-increases-and-capital-composition. 3 https://www.afdb.org/en/news-and-events/press-releases/african-development-bank-

shareholders-approve-landmark-115-billion-capital-increase-signalling-strong-support32344.

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7.4

Islamic Banks and Development Finance Institutions

Islamic banks, being the main players in Islamic finance industry, have the largest asset base and, therefore, are natural candidate for funding infrastructure projects through Shari’ah compliant mechanism though, owing to their liquidity profile and short-term funding base, their risk appetite for such facilities is generally low (Deloitte, 2018; Levy & Iqbal, 2018; A. Rarasati et al., 2019). As mentioned above related to GLCs, since most infrastructure projects involve large amounts of funds, an Islamic bank will usually make a consortium with other Islamic and conventional banks, MDBs, private sector investors and international players to jointly fund these projects through syndicated finance (Abdelkafi & Bedoui, 2016; Ahmed et al., 2015; A. D. Rarasati et al., 2019; Sidlo, 2017). This financing is undertaken in two tiers. The first tier outlines the relationship between the “lead bank” and other financial institutions whereas the second tier delineates financing mechanism to the beneficiary channelled through the lead bank (Ismail, 2012; A. Rarasati et al., 2019). Large Islamic banks in GCC, South Asia and South East Asia are major players in syndicated finance, though looking at the financing structure of Islamic banking sector in selected OIC countries (Ahmed, 2019) found that percentage of investments in infrastructure sectors is not more than 9% of their total financing. Several, complexities arise, however, when both conventional and Islamic finance arrangements are combined in one project finance structure e.g. (i) for Islamic banks, requirement of asset ownership necessitates the identification of specific component of asset, (ii) signing of inter-credit agreement between Islamic and conventional fund providers outlining pro rata utilization of prepayments and pari passu ranking of payment obligations for both Islamic and conventional tranches and (iii) lack of contract standardizations for Islamic financing (Mushtaq & Abdullah, 2018; Sidlo, 2017; The World Bank, 2017). To resolve these issues, governments and bank regulatory authorities need to focus on improving legal framework for syndicated finance and dispute resolution, clarifying tax treatment, standardizing contracts for Shari’ah compliant syndicated financing, permitting Islamic banks to offer long-term restricted profit sharing investment accounts and possibly granting some levy on capital adequacy treatment to banks for financing in infrastructure projects (Abdelkafi & Bedoui, 2016; Ahmed et al., 2015; Deloitte, 2018; A. D. Rarasati et al., 2019; Sidlo, 2017; Woetzel et al., 2016).

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Some OIC countries have development finance institutions such as investment banks, investment companies, industrial development banks, etc., which selectively invest in infrastructure projects (Iqbal & Khan, 2004). The reforms need for Islamic banks mentioned above also apply on such institutions. 7.5

Islamic Capital Markets—Sukuk, Funds and Equity

It has been highlighted in previous sections that issuance of Sukuk has been one of the primary Shari’ah compliant tools to raise funds for infrastructure funding in a variety of projects involving, among others, hydro and solar power generation, telecommunications, airports, seaports, petrochemicals, highways, housing and social infrastructure such as schools and hospitals (Beik et al., 2018; Chu & Muneeza, 2019; Malikov, 2017; A. D. Rarasati et al., 2019; Woetzel et al., 2016). The issuers of these Sukuk include MDBs, sovereigns, GLCs, wealth funds, corporates and private sector. Similarly, structure wise, a wider variety of Shari’ah compliant contracts, product features, tenors and redemption features have been used in Sukuk structures (Ahmed et al., 2015; Mushtaq & Abdullah, 2018). Thus, over the past two decades, sukuk has proved itself to be a versatile asset class for funding the infrastructure, including the projects with considerations for ESG, SRI and green sukuk, with the latter exceeding USD 3 billion during 2019 (Ahmed et al., 2015; Deloitte, 2018; Obaidullah, 2018). Despite a variety of successful experiments cited above, global sukuk issuances data of 2019 exhibits that infrastructure financing is only a small fraction of about USD 160 billion new sukuk issued during the year. According to (IFSB, 2020), 94% sukuk were issued by sovereigns and financial firms, whereas sukuk issuances by utilities, communication services and energy were merely 0.5, 0.3 and 0.1% of the total (Biancone & Radwan, 2018). However, it is expected that in the forthcoming years, green sukuk issuances might surge due to efforts for combating the climate change and meeting the SDG targets (Deloitte, 2018; IFSB, 2020). Given the long-term nature of infrastructure financing, Islamic funds, sovereign wealth funds in OIC countries, Islamic pension funds and takaful undertakings are natural candidate for investing in such projects due to similar time horizon of their investments (Levy & Iqbal, 2018). Nevertheless, such funds remain concentrated in core 5–6 markets

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(contributing over 90% share), lack scale and remains underdeveloped (Chu & Muneeza, 2019; IFSB, 2018, 2020). Similarly, governments, GLCs and other firms involved in building infrastructure projects can raise equity through stock markets. It can be noted from the comparison of total returns generated by S&P Global 1200 Index and S&P Global 1200 Shari’ah Index for 2000–2019 that in most years, the latter has consistently outperformed the former (IFSB, 2020). 7.6

Public–Private Partnership

Enormous gaps for financing the infrastructure in developing countries generally, and OIC countries in particular, cannot be entirely funded by government or affiliated firms, which alludes to the need of involving private sector. Islamic finance and infrastructure PPP projects have several common elements which make them “natural fit” for working together such as returns linked to project, risk sharing, recourse to project revenues and well defined contracts (The World Bank, 2017). In the previous decade, several Shari’ah compliant PPP structures have been implemented in OIC countries such as Pakistan (Karachi Thatta Highway, Master Wind Energy, Liberty Power Tech Limited), Jordan (Queen Alia International Airport), Turkey (Konya Integrated Health Campus, Manisa Training and Research Hospital) and Djibouti (Doraleh Container Terminal Project) (Chu & Muneeza, 2019; IsDB, 2020; The World Bank, 2017). A variety of building blocks are needed to attract private capital for PPP projects, which involve, among others, sound legal framework, regulatory and tax clarity, well established property rights, identification of suitable projects, promulgation of bankruptcy and insolvency laws as well as transparent and effective dispute resolution regime (Abdelkafi & Bedoui, 2016; Khokher, 2019a; The World Bank, 2017). Similarly, a government, based on its economic development programme, needs to establish an infrastructure master plan (Woetzel et al., 2016). Based on this plan, government needs to identify projects that are most suited for funding under PPP structure, with a sound and detailed project evaluation, business plan and technical specifications, outlining the risks and responsibilities of the parties involved during the life cycle of the project (Chu & Muneeza, 2019). Based on these specifications, and consideration for the entire spectrum of sustainability, government shall select the PPP partner(s), leading to construction and execution of the project, with

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a strong follow up and control after completion (Abdelkafi & Bedoui, 2016; Ahmed et al., 2015; Elhadj, 2001; Iqbal, 2019; The World Bank, 2017). For the legal framework, PPP can be implemented either through a separate PPP law and regulations or procurement laws and regulations, depending on whether the jurisdiction follows civil law or common law, since it is less likely to have a separate law in the latter countries (Abdelkafi & Bedoui, 2016; ADB, 2017; Ahmed, 2019). 7.7

Islamic Social Finance—Waqf, Zakat and Sadaqat

Welfare budgets are shrinking globally, and most governments are not finding it challenging to build social infrastructure (Woetzel et al., 2016). Owing to social element, infrastructure such as schools, training institutes for skill development, hospitals, dispensaries, libraries and clean water facilities are not attractive to the commercial private sector (Abdelkafi & Bedoui, 2016). For building such infrastructure, Islamic economic system offers unique tools such as waqf, compulsory and voluntary charity (zakat and sadaqa). In Sect. 6.1, this paper cited the examples of past Muslim empires which, in addition to rulers’ direct funding for infrastructure building, used waqf as a primary mechanism to fill the infrastructure gap. This was made possible with the mass awareness of the waqf concept, the desire of affluent to contribute for the greater good of society and availability of necessary legal and dispute resolution mechanism for waqf (Iqbal, 2019). Several successful attempts have been made in recent decades to revive the institution of waqf by improving the utilization of exiting waqf assets and experimenting with new waqf-related innovations such as introducing corporate waqf, offering waqf deposits by Islamic banks, issuing waqflinked sukuk and reviving cash waqf concept, which was quite common in the Ottoman empire. These examples include: (i) using waqf land to develop a commercial building by Hajj Fund (Tabung Haji) in Malaysia for the Islamic Religious Council, (ii) construction of waqf hotels in Kuala Terengganu, Taiping and Tanjung Keling in Malaysia; (iii) building of a hospital and clinics by Waqf-an Nur, Malaysia, run by Johor Corporation; (iv) construction of 22 mosques in Singapore by a cash waqf built with salary deduction scheme as well as issuance of a musharakah sukuk to fund development of two waqf properties by Majlis Ugama Islam; (v) construction of landmark tourism project in Makkah, called Zamzam Tower, by an innovative sukuk al-intifa to develop waqf properties belonging to King

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Abul Aziz Waqf and (vi) building of two hospitals on waqf land and construction of a secondary boarding school by Dompet Dhuafa NGO in Indonesia, etc. (Hassan et al., 2019; Mohsin et al., 2016). Waqf can be combined with zakat and sadaqa so that the former is used for the construction/establishment of the project whereas the latter two are using to cover the operational cost of providing the facilities (BAZNAS, 2019). Similarly, “greater financialization” of the existing waqf assets is needed to building infrastructure on these lands and generate regular revenues. For this purpose, private sector could be involved through innovative waqf-related structures quoted above. Only in Indonesia, according to one assessment, waqf land is five times than the size of Singapore (4300 sq. kilometers) with an estimated value of USD 27 billion. Similarly, “green awqaf” could be established for developing dedicated projects to support environmentally friendly and sustainable projects. National Zakat Foundation of Indonesia (BAZNAS), with the support of UNDP, has used zakat funds for the development of several microhydro power projects to provide green energy to the deprived sections of society (BAZNAS, 2019; Beik et al., 2018; UNDP, 2017). The key reforms needed to enhance the collection and distribution of zakat funds is to centralize the collection, digitize the operations and apply good governance principles (Ismail, 2018; Khokher, 2019a; A. D. Rarasati et al., 2019). 7.8

Crowdfunding the Infrastructure

Africa’s largest hydropower dam, Renaissance Dam in Ethiopia and a new, 72 kilometer branch of Suez Canal were funded by donations from citizens and investment certificates aimed at locals, diaspora and international investors. In Pakistan, USD 14 billion Diamer-Bhasha Dam is also being partially funded from public donations. (Siddiqui, 2018) discusses the possibility that major infrastructure projects could be partially “crowdfunded” from public by issuing project ownership certificates, in the form of sukuk, but with the caveat that no profits to be paid until the dam is able to generate revenues through producing power. A successful attempt could offer a new model of development finance, would not increase government’s debt burden and offer a social experiment to boost nationalization. Moreover, retail sukuk, issued in routine by Malaysian and

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Indonesian governments could be specifically used for funding small scale or social infrastructure projects (IIFM, 2019).

8 Covid-19 and Impact on Infrastructure Investment The pandemic caused by novel coronavirus has brought unprecedented shock to every facet of human and economic life, including infrastructure projects, and will have both short and long-term impact on the way ongoing projects are executed and investments in such projects are planned and prioritized (Ladley, 2020; Warren, 2020) Governments will be the key decision maker in this respect (Colin et al., 2020). In the short term, governments may prioritize their spending obligations towards projects near completion or healthcare projects, which could negatively affect the gap in infrastructure spending. While many ongoing infrastructure developments delayed (Rahemtulla et al., 2020), some projects not yet initiated may not see the light of day. However, due to lockdowns and low traffic, some ongoing infrastructure projects can get a boost and may be completed relatively quickly such as roads and other urban facilities (Deloitte, 2020; Warren, 2020). Similarly, demand for electricity has become more spread out during the day as people work from home, due to which focus will shift on “energy flexibility and stability projects” (Davisson & Losavio, 2020). While Covid-19 pandemic may or may not be considered a force majeure event (Warren, 2020), depending on the contract interpretations, future infrastructure contracts will have to be more elaborative as debt service, fixed cost payment and stakeholders’ obligation issues come to the fore (Rahemtulla et al., 2020). There will be, however, some beneficiaries of this crisis, impacted by factors such as shifts in behaviour, attitude to risk, exit strategies and most importantly, speed and pattern of economic recovery. Digital infrastructure, including fiber optics, which was considered “core-plus” in the past will transition to become “core” infrastructure. Health and social care infrastructure, telecommunications, data centres and clean energy will also likely get greater attention of the government and communities (Davisson & Losavio, 2020). On the financing side, fast rise in government deficits due to pandemic will induce them to offer greater involvement of private investors in building infrastructure through legal and market-oriented reforms,

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bringing greater transparency and cost effectiveness for operating PPP projects (Colin et al., 2020; Rahemtulla et al., 2020). Similarly, this crisis will open up the doors for relatively newer sectors such as Islamic finance, which has already shown sufficient flexibility and diversity in funding a wide range of infrastructure projects around the globe by the involvement of governments, multilaterals, GLCs and private sector as well as individual investors (Colin et al., 2020; Deloitte, 2018; Levy & Iqbal, 2018). With the need for faster economic recovery, it is estimated that with 1% of GDP going to additional investment in infrastructure, economic output amplifies by 0.4% in the same year and by 1.5% four years later i.e. a 1 dollar invested today could bring returns of 4 dollars in the future. This will lead to the use of advanced technology and focus on ecological preservation to plan, build and operate sustainable infrastructure systems will increase (Davisson & Losavio, 2020). More importantly, tokenizing the debt and equity of infrastructure project by using blockchain technology could considerably reduce the cost, improve liquidity, enhance transparency, broaden investor base and improve transaction efficiency (Iqbal, 2019; Uzsoki, 2019). As summarized by (Davisson & Losavio, 2020), technology and green energy can help “prepare the backbone for carrying the weight of the future”.

9

Concluding Remarks and Moving Forward

The availability of quality, reliable and sustainable infrastructure is key to achieving the SDGs, the targets of which have been greatly hampered with the outbreak of Covid-19. Widespread and persistent economic downturn, increasing unemployment and associated fiscal impact will result in the realignment of priorities for infrastructure projects. This economic shock of the century will bring the core elements of sustainability— covering dimensions of financial, environmental, social and institutional sustainability—to the fore. Similar to the other developing economies, most OIC countries— which are already below their peers in most infrastructure indicators—face enormous infrastructure funding gaps. Due to relative complexity and enormous size of infrastructure projects, all the investment gap cannot be filled by the governments alone. This paper showed that whereas most financing arrangements available through conventional finance have been suitably modified and applied through Shari’ah compliant mechanisms in

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a variety of infrastructure projects throughout the world, Islamic social finance offers additional mechanism to build and operate those projects which are otherwise not commercially viable. Governments, as a primary source of infrastructure development in any country, have both domestic and international sources at their disposal. However, for OIC countries, key prerequisites for the greater use of Islamic financial system for infrastructure development will be for governments to demonstrate greater commitment and issue public commitment to partially fund annual and medium-term development plan through Islamic finance tools and undertake necessary reforms in legal, tax and regulatory regime to facilitate greater use of available Shari’ah compliant tools and the development of new ones (Abdelkafi & Bedoui, 2016). Such reforms can be combined with financial incentives for using Islamic finance such as tax breaks and concessions on registration fee and stamp duty payment, especially for issuing sukuk. Similarly, governments need to identify a pipeline of viable4 infrastructure projects where private sector could be involved (Ra & Li, 2018). GLCs in some countries have been an active player in raising Shari’ah compliant funds for infrastructure building. Coupled with other government linked and private sector financial institutions focusing on long-term investments such as sovereign wealth funds, Islamic investment companies, pension funds and takaful undertakings, a range of options and funding sources are now available for raising Shari’ah compliant funds for infrastructure development in both OIC and non-OIC countries. Similarly, a dedicated infrastructure investment bank can be established at domestic level, the capital which can be funded by government, GLCs, major Islamic banks and interested corporates. Islamic banks, despite being about three fourth of commercial Islamic finance sector, are not major players in infrastructure financing due to, among others, their relatively short-term liability profile, high capital requirements on long-term funding and lack of expertise. However, regulatory reforms to reduce capital requirements can be combined with other reforms such as making investment accounts in Islamic banks fully loss

4 The terms investible, bankable or viable are used for those infrastructure projects which generate sufficient economic and financial returns from the underlying revenue stream (such as tolls in case of highway, utility bills in case of electricity, etc.) over their lifetime so that they become attractive for private investors to fully or partially sponsor the project.

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absorbent (such as done in Malaysia through promulgation of Islamic Financial Services Act 2013) or transferring them into an off-balance sheet fund or into a subsidiary, as proposed by (Archer & Karim, 2009). Similarly, since most Islamic banks finance infrastructure projects through syndicated finance by becoming part of a consortium, legal and regulatory reforms for dispute resolution and arbitration, tax treatment, capital adequacy and co-financing could be undertaken (Abdelkafi & Bedoui, 2016; Biancone & Radwan, 2018). Most MDBs, except IDB Group entities and ADB for a few token projects, have made little progress on providing Shari’ah compliant project financing for infrastructure purposes. Though partially such lack of interest can be attributed to lack of demand by the Ministries of Finance in OIC countries to seek Shari’ah compliant financing arrangement from MDBs, the MDBs themselves have not taken much steps beyond writing papers, organizing awareness seminars and providing technical assistance on legal and regulatory aspects of Islamic finance (Kumar & Arora, 2019). Their core function of providing finance has, however, not been able to get fuller attentions to the management of major MDBs, including the World Bank, ADB, AfDB and AIIB, etc. (Khokher, 2019a; Kumar & Arora, 2019). In addition, to increase supply, IDB needs to increase its own capital base, enhance collaboration with other conventional MDBs for establishing more infrastructure-focused joint funds and enter into co-financing of major projects in common member countries. Similarly, establishment of one or more dedicated Islamic infrastructure banks, including that proposed by the State of Qatar focusing on energy, need to be pursued with fuller commitment and vigour. Islamic capital market, especially sukuk, has proved its versatility and agility to finance infrastructure projects in a wider range of settings— from telecommunications, energy, highways, airports and ports to schools and hospitals, though such projects constitute only less than 10% of outstanding sukuk as on December 2019 (Chu & Muneeza, 2019; Deloitte, 2018; Levy & Iqbal, 2018). However, numerous successful experiments of sukuk issuances to fund sustainable infrastructure demonstrate that post pandemic, sukuk have a greater chance of being at the forefront for funding raising to combat climate change and meet SDG targets (ADB, 2017; Sidlo, 2017). Moreover, though Islamic funds, life takaful companies and Islamic pension funds are natural candidates for providing infrastructure funding due to their long investment horizon,

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they need to first achieve economies of scale to successfully become partner in infrastructure investment arrangements. For promoting greater involvement of private sector, apart from required legal reforms, governments need to establish a dedicated entity to market, implement and monitor the PPP projects and provide advisory, where needed (ADB, 2017). Moreover, dedicated institutions for providing guarantee and insurance through Shari’ah compliant mechanism shall need to be established at domestic and international level (Abdelkafi & Bedoui, 2016). In addition, greater involvement of civil society organizations should be encouraged to achieve social sustainability in infrastructure projects and greater involvement of target communities. Finally, there is a tremendous scope of reviving and reforming existing waqf management and zakat collection and distribution arrangements. Several recent case studies in this paper exhibited how institutional reforms and use of arrangements such as cash waqf can provide additional resources to the governments and societies for building social infrastructure.

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Rarasati, A. D., Trigunarsyah, B., Lamari, F., & Too, E. (2019). Islamic financing for Indonesia infrastructure project: Mini hydropower plant case studies. Infrastructure Asset Management, 6, 195–205. https://doi.org/10.1680/ jinam.18.00004. Renima, A. (2016). The Islamic golden age: A story of the Triumph of the Islamic civilization. In A. Renima, H. Tiliouine, & R. J. Estes (Eds.), The state of social progress of Islamic societies (pp. 25–52). Springer International. Savage-Smith, E. (2019). Islamic culture and the medical arts: Hospitals [WWW Document]. U.S. National Library of Medicine. https://www.nlm.nih.gov/ exhibition/islamic_medical/islamic_12.html. Sawada, Y. (2019). Infrastructure investment needs and sources of financing. Siddiqui, H. U. (2018). How to give a dam? dawn.com. Sidlo, K. W. (2017). Sharia-compliant investments in infrastructure and development capital financing, CASE—Center for Social and Economic Research. Institute of Development Studies. Sierra, L. A., Pellicer, E., & Yepes, V. (2017). Method for estimating the social sustainability of infrastructure projects. Environmental Impact Assessment Review, 65, 41–53. https://doi.org/10.1016/j.eiar.2017.02.004. The World Bank. (1994). World development report 1994: Infrastructure for development, population and development review. https://doi.org/10.2307/197 3669. The World Bank. (2017). Mobilizing Islamic finance for infrastructure public– private partnerships. UN. (2001). Indicators of sustainable development. New York: United States UN. (2015a). Transforming our world: The 2030 agenda for sustainable development, sustainable development goals 2030. https://doi.org/10.1201/b20 466-7. UN. (2015b). UN Addis Ababa action agenda—Financing for development. Addis Ababa. UNDP. (2014). Islamic finance and impact investing. https://doi.org/10. 1002/ejoc.201200111. UNDP. (2017). Integrating the SDGs into development planning: Indonesia, Country briefs on SDG integration into development planning. UNESCO. (2019). Darb Zubayda (Pilgrim Road from Kufa to Makkah) [WWW Document]. UNESCO World Heritage-Tentative List. https://whc.unesco. org/en/tentativelists/6025/. Uzsoki, D. (2019). Tokenization of infrastructure. Wan, G., & Zhang, Y. (2017). The direct and indirect effects of infrastructure on firm productivity: Evidence from manufacturing in the people’s Republic of China (No. 714) (ADBI Working Paper Series). Warren, D. (2020). COVID-19 and major infrastructure projects: Managing the impact. Mondaq.

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Woetzel, J., Garemo, N., Mischke, J., Hjerpe, M., & Palter, R. (2016). Bridging global infrastructure gaps. McKinsey & Company. Woetzel, J., Garemo, N., Mischke, J., Kamra, P., & Palter, R. (2017). Bridging infrastructure gaps has the world made progress?. McKinsey & Company. World Bank Group. (2008). Sustainable infrastructure action plan 2009–2011. Washington DC USA. Zeti Akhtar Aziz, T. S., Idris, A., & Sultan, Y. (2019). Responsible finance— Ethical and Islamic finance: Meeting the global agenda.

PART II

Islamic Finance and Factors of Environmental, Social and Governance (ESG)

CHAPTER 9

Sustainable Finance and a Shar¯ı’ Analysis of Environmental, Social and Governance (ESG) Criteria Aminudin Ma’ruf, Ziyaad Mahomed, and Shamsher Mohamad

1

Introduction

Over recent years, Sustainability has been an important topic of interest among researchers and practitioners in finance, evidenced by the remarkable increase in the number of research studies and regulations on the topic (Clark et al., 2015). Initiatives on Sustainability include the concepts of Sustainable Investment; Sustainable Responsible Investing (SRI), Corporate Social Responsibilities (CSR) and Environmental, Social and Governance (ESG) (Cheng et al., 2014). In addition, several reporting standards have been issued by accounting bodies to facilitate reporting

A. Ma’ruf · Z. Mahomed (B) · S. Mohamad INCEIF, Kuala Lumpur, Malaysia e-mail: [email protected] S. Mohamad e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8_9

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of ESG based activities of firms in their financial reporting. Some examples are the Global Reporting Initiative (GRI), the Carbon Disclosure Project (CDP) and the Sustainability Accounting Standard Board (SASB). On a similar note, the concept of ethical financing has gained attention among researchers and practitioners in the financial industry, evidenced by the increasing number of responsible investment forums such as the Middle East Sustainable Investment Forum (MESIF), European Sustainable Investment Forum (Eurosif), the Forum for Sustainable and Responsible Investment (USSIF), Global Alliance for Banking on Values (GABV), and the Global Sustainable Investment Alliance (GSIA). Internationally, the United Nations Sustainable Development Goals (UN SDGs) have been a global compass for ethical financing and sustainability for 193 member countries since its launch on 25 September 2015. This has increased public awareness of sustainability issues and issuing sustainability reports among many firms globally. For example, approximately three quarters of 4900 companies from 49 countries around the world have issued corporate responsibility reports and 78% of the world’s top companies (G250) are including corporate responsibility (CR) data in their annual reports, a strong indication that they believe CR data is relevant for their investors (KPMG, 2017). Islamic finance is a financing and investment system that contributes positively to the fulfilment of the socio-economic objectives of society. Refraining from Rib¯a (usury), Gharar (uncertainty) and Maysir (gambling) are some of the ways in achieving the goal (Dusuki, 2011). In the Islamic code of life, it is believed that corruption appearing throughout the land and sea is caused by human hands.1 Consequently, as the caliph (representative) of Almighty Allah, human beings have a responsibility to look after the earth. Preserving human social order and promoting the well-being of humanity through the support of the economy are among the primary aims of the Shar¯ı’ah. A deep investigation of the Qur’anic verses and Prophetic traditions dealing with property and wealth provide a bulk of evidence that wealth has an important status according to the Shar¯ı’ah ¯ ur, 2006). The International Islamic Fiqh Academy (IIFA), of (Ibn’Ash¯ the Organization of Islamic Cooperation (OIC) issued its resolution on 1 “Corruption has appeared throughout the land and sea by (reason of) what the hands of people have earned so He may let them taste part of (the consequence of) what they have done that perhaps they will return (to righteousness)” (Qur’an 30:41).

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the environment and its preservation from an Islamic perspective which simultaneously encouraged the society to establish an organization related to this matter to develop solutions for the next generation (IIFA, 2009). Generally, ESG concepts and Shar¯ı’ah criteria hold the same objective on promoting positive values in conducting business. Both the ESG concept and Shar¯ı’ah criteria share some similarities on preserving environment, socio-economic development and good governance of the financial industry. However, they use different approaches to achieve these objectives. In most cases, the Shar¯ı’ah criteria focus on the prevention of harm rather than setting goals in doing good alone. Conversely, ESG concepts seem focussed on setting the goals and reaching some metrics (Binmahfouz, 2017). This chapter analyses the convergent and divergent areas of both ESG and Shar¯ı’ah rules and principles and explores ESG initiatives from the Shar¯ı’ah perspective. The rest of the chapter is organized as follows. Section 2 presents the review of general Shar¯ı’ah literature on ethical financing and ESG. Section 3 presents the approach applied in conducting the analyses and the remaining sections report on the theme discussion, conclusion and recommendations.

2

Literature Review 2.1

ESG Concepts

ESG concepts aim to bring the financial industry into a different level which is “beyond profit”, meaning that financial industry needs to consider environment and social aspects while simultaneously looking at their profitability. Brooks and Oikonomou (2018), have investigated the effects of ESG on firms’ value by summarizing the key findings of 45 years of empirical research in accounting and finance. They conclude that ESG disclosures are generally associated with better ESG performance as well as firm performance. Bodhanwala and Bodhanwala (2018) observed that in India, ESG disclosure has a significant positive relationship to the company’s performance. It is also found that ESG practices have influenced economic performance among Malaysian and Singaporean companies (Tarmuji et al., 2016). Other studies that document a positive correlation between ESG disclosure and firm value are Fatemi et al. (2017), Buallay (2018) and Li et al. (2018).

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Despite the overwhelming evidence of positive relationship between ESG activities and firm performance, there is evidence to the contrary. Carroll (1999) documented that the prominent economist Milton Friedman disagreed about the link between ESG activities and firm value and explained that the concept of this proposed link is unjustified and undemocratic tax towards shareholders because only people can have responsibilities whereas a corporation is just an artificial person. Studies which highlighted the missing link between ESG concepts and financial performance argue the non-connectivity of Environmental, Social and Governance initiatives by firms. Hoi et al. (2013) insinuate that ESG initiatives are in reality tax avoidance practices that will ultimately reduce government revenue and increase cost to society. Guthrie and Parker (1989) reported that firms were mainly reporting on social values on human resource and community involvement rather than environmental issues such as pollution and deforestation. Clarkson (1995) and Hillman and Keim (2001) categorized stakeholder groups involved in ESG theory into primary and secondary categories and concluded that ESG activities do not create value for any category of stakeholder in the firm. The concept of materiality is believed to be the best way to gauge the sustainability of a company. As a global standard reporting initiative, Global Reporting Initiative (GRI) defines materiality as “the threshold at which aspects become sufficiently important that they should be reported” (GRI, 2015). The Sustainability Accounting Standard Board (SASB) and Morgan Stanley Capital International (MSCI) suggest five broad concepts of sustainable aspects which are environment, social capital, human capital, business model and innovation, leadership and governance. Ernst and Young (2015) conducted a survey on Materiality and Sustainability disclosure based on the Singapore Exchange (SGX) top 50 listed companies and reported that there is a significant space for improvement in the quality of sustainability reporting. It also found that the materiality concept is gaining traction among the stakeholders and most of the materiality reports are guided by the GRI (EY, 2015). Different from others, GRI promotes standardized sustainability reporting which is applicable to all companies and provides them free Sustainability Reporting Guidelines. In a similar context, the International Integrated Reporting Council (IIRC) has developed a guideline on International Integrated Reporting (IR) for sustainability that focus the

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materiality of the company from three aspects: the relevant matters, the influence of those matters to the organization’s ability in creating value over time and the prioritization of the above matters (IIRC, 2013). Given the focus and scope of this study, the relevant discussion of ESG initiatives is analyzed within the context of Maq¯asid Al-Shar¯ı’ah (Objectives of Shar¯ı’ah) and Fiqh Al-Mu’¯amalat (Juristic Study of Transactions). ¯ ur (2011) in his book Maq¯asid As-Shar¯ı’ah Al-Islamiyyah briefly Ibn’Ash¯ discusses the objectives of Shar¯ı’ah in financial transactions; the status of wealth according to Shar¯ı’ah, earning, the validity and invalidity. AlGhaz¯al¯ı (2013), offers brief information on the virtues of earning and encouragement towards it (Al-Lub¯ ud¯ı, 2012). Whereas Kit¯ab Al-Kasb of Al-Imam Muhammad ibn Al-Hasan Al-Shaybani provides a comprehensive discussion on earnings; from its meaning, legal status, permissibility and impermissibility (Al-Shaybani, 2011). The overall objectives of the Shar¯ı’ah law is all about providing benefit and averting harm. Almighty Allah has stated in the Qur’an that He wishes ease for human beings and does not intend for hardship.2 Islamic finance as a Shar¯ı’ah-based business entity, has to ascertain that accumulation and allocation processes of wealth in the business are in compliant with Shar¯ı’ah (Dusuki, 2011). Islamic finance is much more than just refraining from riba, gharar and maysir but it is a holistic system which aims to contribute towards the fulfilment of the socio-economic objectives and the creation of a just society. Thus, Islamic finance characteristics are shaped by the objectives of Islamic law, which aims at overall social and economic good and alleviates greed and individualism (Dusuki & Bouheraoua, 2011). Islam not only encourages people to work but also values the effort. In fact, all messengers of Allah worked for their living. Adam (AS) was a farmer, Idris (AS) was a tailor, Noah (AS) was a carpenter, Hud (AS) was a merchant, Ebrahim (AS) was a shepherd, Dawud (AS) was an armour maker, Sulaiman (AS) was a mat weaver, Moosa (AS) was a labourer and the Prophet Muhammad (SAW) was a trader (Sadr, 2016). From a Shar¯ı’ah perspective, wealth is regarded as a means and not an objective. The deviation of wealth accumulation and allocation from its right path will not serve the objectives of Shar¯ı’ah (Maq¯asid Shar¯ı’ah), which means it has served the purpose of human beings rather than the

2 “… Allah intends for you ease and does not intend for you hardship” (Qur’an 2:185).

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purpose defined by the creator, the real owner of all wealth (Lahsasna, 2013). Laldin (2008) found that there are several objectives of Shar¯ı’ah in financial transactions, such as continuity of the circulation of the wealth, continuity of the investment of wealth, achieving comprehensive communal prosperity, financial transparency and validation of financial ownership. Both the conventional and Shar¯ı’ah concepts have similar ways of acquiring and allocating wealth by doing good or no injustice to any party, however, for ESG initiatives, the criteria based on Shar¯ı’ah rules and principles might have different values and purposes. This chapter assesses the underlying values and purposes of both concepts t to fill the literature gap.

3

Methodology

A qualitative analysis of both primary and secondary sources of Islamic law to analyze the evolution and current status of ESG and the underlying value of ESG and Islamic Finance in relation to Shar¯ı’ah. The focus is on the Shar¯ı’ah related concepts of Khal¯ıfah (Stewardship), M¯ızan (Equilibrium or Balance) and Ihs¯an (Perfection or Excellence) related to ESG. To understand the ESG concept from both perspectives, an analysis of the similarities and differences on each sub-element of ESG in relation to Shar¯ı’ah rules and principles will be conducted by comparing the MSCI ESG Ratings Methodology and the application of Shar¯ı’ah rules and principles.

4 4.1

Findings and Discussion Shar¯ı’ah Principles Related to ESG

Islam is not merely a religion but it’s also a way of life. As such Islam places great focus on individual worship (‘ib¯ad¯at) and interpersonal transactional relationship (mu’¯amal¯at) in all matters. In order to live a fully Islamic life, it is not sufficient for a person to perform an individual worship without fulfilling the interpersonal transactional

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relationship3 (Al-Ghaz¯al¯ı, 2013). An analysis of the all-purpose principle (maqsad ‘¯amm) of the Islamic legislation suggests preservation of the social order of the community and ensure its healthy progress for ¯ ur (2006) the public benefit (maslahah mursalah or ‘¯ammah). Ibn’Ash¯ expressed that maslahah is of two kinds: public and private. Public interest (Maslahah ‘¯ammah) consists of what is beneficial and useful for the whole or most of the community whereas private interest (maslahah kh¯assah) consists of anything that benefits the individual. Different from its counterpart, Islamic finance has a value proposition which is based on the Qur’an and Sunnah of the Prophet which are binding and cannot be changed while others may be changed according to the Ijtih¯ad (reasoning) of the scholars. In addition, all these principles are rooted into the primary sources of Islam, the Qur’an and the Sunnah of the Prophet (Kamali, 2003). As an illustration, the prohibition of Riba (usury),4 Gharar (uncertainty)5 and Maysir (gambling)6 are based on the main sources of Islam. These form the basis of good ethics in Islam. But unlike conventional law, good ethics in Islam are binding and form part of the law rather than behaviour that is simply good for practice. The Muslim philosopher Fakhr al-D¯ın al-R¯az¯ı defines the ethical value in his book Muhassal as follows (Shihadeh, 2006): “Goodness’ (husn) and ‘evil’ (qubh) may be intended to refer to (a) agreeability (mul¯ a’ama) and disagreeability (mun¯ afara) to disposition (tab’), and to (b) something being an attribute of perfection or imperfection”. He further discussed the subjectivity of the value in his early work the Ish¯ara, which he mentioned: “Man designates the word ‘good’ (hasan) for what agrees with his ends (w¯ afaqa gharadah), and the word ‘bad’ (qab¯ıh) for what contradicts (kh¯ alafa) his ends. Accordingly, a thing may be good in relation to one person, but bad in relation to 3 “But seek, through that which Allah has given you, the home of the Hereafter; and (yet), do not forget your share of the world. And do good as Allah has done good to you. And desire not corruption in the land. Indeed, Allah does not like corrupters” (Qur’an 28:77). 4 “… This is because they say, “trade is (just) like interest”. But Allah has permitted trade and has forbidden interest” (Qur’an 2:275). 5 Abu Huraira (Allah be please with him) reported that Allah’s Messenger forbade a transaction determined by throwing stones, and the type which involves some uncertainty (Sahih Muslim 1513, Book 21, hadith 8). 6 “O you who believed, indeed, intoxicants, gambling (sacrificing on) stone alters (to other than Allah), and divining arrows are but defilement from the work of Satan, so avoid it that you may be successful” (Qur’an 5:90).

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another”. In brief, it is known that the ESG is an ethically based concept that can be changed through time and circumstances while Islamic finance is religion-based which contains both the static and dynamic rulings and principles. Although the interpretation of the Qur’an and Sunnah might differ among the scholars, the ethical principles and values it espouses, remain within the scope and not based on the social norm. The guides provided by Islam are mostly general and it is an obligation for Muslims to interpret it into practical ways. From the perspective of principle and value of business activities, there is a divergence between Shar¯ı’ah and ESG concepts. The Shar¯ı’ah principles of Islamic Finance come with a more sustainable framework compared to ESG which has specific practical forms (RFI Foundation, 2018). Other concepts which are similar are between CSR and Charity (sadaqah). The CSR concept is usually practised on a philanthropic basis and is similar to the concept of charity (sadaqah) in Islam, which is considered as a cost centre rather than a profit centre (BNM, 2018). However, there are some differences between both concepts in the sense that the former is voluntary while the latter comes with two forms, mandatory and voluntary. Another key difference is that the CSR concept covers both social and environment in a voluntary practice while mandatory charity (zak¯ah) covers only the social aspect and voluntary charity (waqf, qard hasan) has a similar role as CSR, covering both social and environmental attributes. These differences are illustrated by the diagrams (Fig. 1). In short, Islamic finance has an untapped potential for developing sustainable finance concepts with the embedded ethical values inside its core principles. The elimination of riba (usury), gharar (uncertainty), maysir (gambling) and implementation of zak¯ah are the basic solutions of unsustainable finance. However, the duty of Islamic finance is to further transform the concepts of ihs¯an, m¯ızan and voluntary charities into an actionable activity for the benefit of the society. In reality, the lack of expertise and proper regulations to govern the activities are the main constraints in developing sustainable business practices (RFI Foundation, 2018). As an example, in 2017, the central bank of Malaysia (Bank Negara Malaysia (BNM)) released the concept of Value-based Intermediation (VBI) under the strategy paper entitled Value-based Intermediation:

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a

201

b Ihsan & Mizan

ESG

Prohibition of riba, gharar and maysir

Waqf & Qard Hasan

CSR

Zakāt (mandatory charity)

Fig. 1 Distinctive values of ESG concept from Shar¯ı’ah principles. Diagram A: The concepts of social and environmental finance within the business activities. Diagram B: The concepts of social and environmental finance which are separated from business activities

Strengthening the Roles & Impact of Islamic Finance.7 The main idea of VBI is to promote the objectives of Shar¯ı’ah through practices through the Islamic finance industry. Different than others, VBI drives the industry towards sustainability by looking at the best practices of ethical finance and bases its principles on Shar¯ı’ah. In practice, the Islamic finance industry is merely concerned with compliance issues whereas the VBI initiative foster the business practices of the Islamic financial industry beyond Shar¯ı’ah compliance by delivering on the objectives of Shar¯ı’ah and generating sustainable impact for the economy, community and environment (BNM, 2018).

7 http://www.bnm.gov.my/index.php?ch=en_announcement&pg=en_announcement& ac=555.

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4.2

ESG from the Shar¯ı’ah Perspective

Synergies and Contradictions of ESG Elements from Shar¯ı’ah Principles Islamic principles which are embedded at the core body of Islamic finance mainly cover the concepts of Socially Responsible Investment (SRI) and ESG integration. There are several concepts in Islam which are aligned with the concept of ESG-based acitivites; namely stewardship (khal¯ıfah),8 trust (am¯anah),9 equilibrium or balance (m¯ız¯an),10 and ihs¯an.11 These concepts denote the importance of environmental, social and governance in Islam by enjoining good and forbidding wrong (al-amr bi al-ma’r¯uf wa an-nahy ‘an al-munkar).12 On top of that, the foundation of Islamic finance has established some principles to block the root of the problem that might lead into corruption in society and environment. This attempt has been done by excluding usury (rib¯a), uncertainty (gharar), and gambling (mays¯ır) which are deemed as the main sources of harm. Those prohibitions are intended to avoid inequitable distribution and unfair exchange of wealth in the economic system (ISRA, 2011). As a religion, Islam comes with the specific (dal¯ıl tafs¯ıl¯ı) and general evidence (dal¯ıl ijm¯al¯ı or kull¯ı) (Kayadibi, 2010). Some of the Shar¯ı’ah principles related to ESG are in specific evidence. An example in the Qur’an is: “But Allah has permitted trade and has forbidden interest ” (Qur’an 2:275). It indicates a rule that forbids interest. As compared to the specific evidence, there are some evidence in Islam which are related to ESG in a more general meaning. It is mentioned in the Qur’an: “And

8 “And (mention, O Muhammad), when your Lord said to the angels, “Indeed, I will make upon the earth a successive authority”. They said, “Will You place upon it one who causes corruption therein and sheds blood, while we declare Your praise and sanctify You?” Allah said, “Indeed, I know that which you do not know” (Qur’an 2:30). 9 “Indeed, we offered the Trust to the heavens and the earth and the mountains, and they declined to bear it and feared it; but man (undertook to) bear it. Indeed, he was unjust and ignorant” (Qur’an 33:72). 10 “Indeed, all things We created with predestination” (Qur’an 54:49). 11 “And spend in the way of Allah and do not throw (yourselves) with your (own)

hands into destruction (by refraining), and do good; indeed, Allah loves the doers of good” (Qur’an 2:195). 12 “You are the best nation produced (as an example) for mankind. You enjoin what is right and forbid what is wrong and believe in Allah” (Qur’an 3:110).

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do good as Allah has done good to you. And desire not corruption in the land. Indeed, Allah does not like corrupters ” (Qur’an 28:77). The verse points out the encouragement of doing good and the prohibition of bad deeds in general. In contrast, conventional business ethics are driven by certain philosophical foundations justifying moral principles and values. Iqbal and Mirakhor (2017) mentioned that there are three philosophical perspectives underlying business ethics theory: teleological, deontological and virtue ethics. From the underlying principles between Islamic business ethics and conventional business ethics, both concepts are expected to converge on some values and diverge on others. Table 1 explains the value-based exclusions required by Shar¯ı’ah for responsible investments. Synergies and Contradictions of Environmental Elements from Shar¯ı’ah Principles The environmental elements are much debated and focus specifically from the investment perspective. Investors demand that fund and asset managers ensure that ESG compliance is met in managing the funds. These investors firmly believe that incorporating ESG values in managing the portfolios is the best business practice, which is supported by empirical evidence. From the Shar¯ı’ah perspective, the concept of ‘amal (deliberate action, work or deed) in general and tij¯ arah (trade or business) in particular is not only permitted but greatly encouraged (Ahmad, 1995). It is mentioned in the Qur’an: “O you who have believed, do not consume one another’s wealth unjustly but only halal (in lawful) business by mutual consent. And do not kill yourselves (or one another). Indeed, Allah is to you ever Merciful ” (An-Nis¯a’:29). Another concept of trade in Islam that supports the environmental component of ESG is the concept of Halal (lawful) and Haram (prohibited). The concept of Halal and Haram requires Muslims to deal with Halal business and avoid the Haram.23 The distinction of Halal and Haram does not only look at the outcome of the product, but also that the means in achieving the goals must be legitimate and the principle is applied in the spending of wealth as much as it is in acquisition (Ahmad, 23 “… Who enjoins upon them what is right and forbids them what is wrong and makes lawful for them the good things and prohibit for them the evil and relieves them of their burden and the shackles which were upon them…” (Qur’an 7:175).

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Table 1

Shar¯ıah bases of value-based exclusions

Values-based exclusions

Shar¯ı’ah basis

Controversial weapons

In Islam, killing a Muslim is considered a major sin and will face a severe punishment in the hereafter. As mentioned in the Qur’an: “But whoever kills a believer intentionally – his recompense is Hell, wherein he will abide eternally, and Allah has become angry with him and has cursed him and has prepared for him a great punishment ”13 It is prohibited to sell a commodity that might be used in the commission of sin. This includes selling weapons during periods of fitnah (confusion or instability). Its prohibition is based upon the knowledge of the intention or evidence supporting the suspicion. It is stated in the Qur’an: “And cooperate in rectitude of the purpose or evidence supporting the suspicion. It is stated in the Qur’an: “And cooperate in righteousness and piety, but do not cooperate in sin and aggression. And fear Allah; indeed, Allah is severe in penalty”14 Islam truly values the life of a person. According to the principle of Islam, killing a soul is regarded as killing mankind entirely. It is mentioned in the Qur’an: “whoever kills a soul unless for a soul or for corruption (done) in the land – it is if he had slain mankind entirely. And whoever saves one – it is if he had saved mankind entirely”15 Islam condemns the use of tobacco as potentially harmful or damaging to one’s health. It has been stressed in the Qur’an: “And do not throw (yourselves) with your (own) hands into destruction (by refraining)”16 Regarded as an abomination, Islam prohibits alcohol as is explained in the Qur’an: “O you who believe, indeed, intoxicants, gambling (sacrificing on) stone alters(to other than Allah), and divining arrows are but defilement from the work of Satan, so avoid it that you may be successful ”17 Adult entertainment is considered as f¯ahishah (shameful deeds) in Islam, it is strictly prohibited as explained in the Qur’an: “And do not approach unlawful sexual intercourse. Indeed, it is ever an immorality and is evil as a way”18

Civilian firearms

Nuclear weapons

Tobacco

Alcohol

Adult entertainment

(continued) 13 Qur’an 4:93. 14 Qur’an 5:2. 15 Qur’an 5:32. 16 Qur’an 2:195. 17 Qur’an 5:90. 18 Qur’an 17:32.

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(continued)

Values-based exclusions

Shar¯ı’ah basis

Conventional weapons

It is prohibited to sell a commodity that might be used in the commission of sin. Selling weapons during periods of fitnah (confusion or instability). Its prohibition is based upon the knowledge of the intention or evidence supporting the suspicion. It is stated in the Qur’an: “And cooperate in righteousness and piety, but do not cooperate in sin and aggression. And fear Allah; indeed, Allah is severe in penalty”19 Gambling is prohibited in Islam as it may lead to several crimes. The Qur’an has explained it: “Satan only wants to cause you animosity and hatred through intoxicants and gambling and to avert you from the remembrance of Allah and from prayer. So, will you not desist?” 20 In principle, Islam prohibits changing the creation of Allah. It is explained in the Qur’an: “Whom Allah has cursed. For He had said, “I will surely take from among Your servants a specific portion. And I will mislead them, and I will arouse in them (sinful) desires, and I will command them so they will slit the ears of cattle, and I will command them so they will change the creation of Allah”21 The using of nuclear power is depending on its benefit and harm, as the ruling of Islam always looks at a consideration of the two aspects. The Islamic legal maxim says: Averting harm takes precedence over achieving benefit (ISRA, 2013) Shar¯ı’ah emphasizes on communal obligation—which is preserving the environment—over the individual obligation. The basis of preserving the environment is explained in the hadith of the Prophet: “Whoever kills a young man or an adult, or burns a palm tree, or cuts a fruitful tree, or slaughters a sheep to hurt her, he comes back empty-handed”22

Gambling

Genetically modified organism

Nuclear power

Thermal coal

Source MSCI SRI indexes methodology (February 2021)

19 Qur’an 5:2. 20 Qur’an 5:92. 21 Qur’an 4:118–119. 22 Musnad Ahmad: 22368.

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1995). It is narrated that the second Caliph, ‘Umar bin Al Khatt¯ab once said: “indeed this wealth is not valid except in three conditions: it is taken by rightly, it is given in a right way and it prevents any evil ” (Al-Ansh¯ar¯ı, 2015). This condition denotes that it is not good enough to gain something in a right way but must also be spent in a manner that does not involve any element of injustice. As mentioned earlier, preserving the environment from the Shar¯ı’ah perspective must comply with the concept of m¯ızan (equilibrium or balance) that is to utilize the environment responsibly. It is believed that Allah has created all creation to maintain equilibrium and harmony (RFI Foundation, 2018). To facilitate the analysis of the ESG rating methodology from both Shar¯ı’ah and conventional perspective, Table 2 summarizes the similarities and differences. Islamic investment principles avoid investment in industries that violate the value systems and beliefs of Islam in their operation. Certain types of industries such as alcohol, tobacco, arms and defence, pornography, etc. are excluded from the investment list (Ghoul & Karam, 2007). Similarly, both concepts of investment, ethical and Islamic, screen out the investment that is consistent with Islamic beliefs and ethical values. Unlike the unrestricted conventional investment portfolio, ethical and Islamic investment portfolios are more restricted in their screening criteria and therefore they tend to have a relatively smaller investment universe and probably higher residual risk. For example, Statman (2006) found that 50% of the conventional Standard and Poor’s 500 index constituents were removed from the Domini Social Index because of their violation to SRI criteria. The exclusion of Tobacco, Alcohol, Pornography, Weapons and Gambling is considered as overlapping areas of ESG, responsible and Islamic investment. Even though those concepts are excluding the same product criteria the basis of the exclusion is different. Socially responsible investment excludes the criteria based on the ethical norm of the society which might change in the future following the customary practices of the society, whereas the exclusion of the criteria in Islamic investment is based on the religious values which will not change even if the societal norm changes. However, there is a divergent area between Islamic and ethical financing criteria. For religious purposes, Islamic investment exclude pork-related products which are prohibited in Islam. This criterion is based on the Qur’anic verse: “He has only forbidden to you dead animals, blood, the flesh of swine, and that which has been dedicated to other than

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Table 2

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Environmental element of ESG and its Shar¯ı’ah values

ESG pillars

ESG themes

Shar¯ı’ah basis

Environment

Climate Change

Islam considers Climate Change as a sort of damage, alteration and mischief caused by human beings. In one of its verses, the Qur’an regarded mischief as a crime and calls attention to the retribution awaiting those who do it: “And do not mischief on the earth after it has been set in order”24 It is a duty of the current generation to preserve the ecosystem for the next generation without dilapidating or polluting its resources and potentials. To this effect, the Qur’an states: “And the earth – we have spread it and cast therein firmly set mountains and caused to grow therein (something) of every well-balanced thing. And We have made for you therein means of living and (for) those for whom you are not providers. And there is not a thing but that with Us are its depositories, and We do not send it down except according to a known measure. And We have sent the fertilizing winds and sent down water from the sky and given you drink from it. and you are not its retainers ”25 The protection of water, air and earth from pollutants is an individual religious duty of every Muslim. It is reported that the Prophet (PBUH) had said: “You should not pass urine in stagnant water which is not flowing then (you may need to) wash in it ”26 The development of a society is depending on their consciousness. It is mentioned in the Qur’an: “Indeed, Allah will not change the condition of a people until they change what is in themselves ”27

Natural resources

Pollution and waste

Environmental opportunities

Source MSCI ESG research key issue hierarchy (November 2021)

24 Qur’an 7:56. 25 Qur’an 15:19–22. 26 Sahih al-Bukhari 239, book 4, hadith 106. 27 Qur’an 13:11.

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Allah” (Qur’an 2:173). Other than that, the guidance of Islam is mostly that of permissibility. As a principle and value of business activities, this aspect of Shar¯ı’ah shows its difference from ESG concept, Shar¯ı’ah as the underlying principles of Islamic Finance comes with a general framework of sustainability while ESG has significant and practical forms of it (RFI Foundation, 2018). It is observed that Islamic investment criteria are more focussed on excluding some religious non-compliance elements rather than including some of ESG aspects which are also aligned with the value of Islam. This reality depicts the practice of the concept of enjoining good and forbidding wrong (al-amr bi al-ma’r¯uf wa an-nahy ‘an al-munkar).28 It is suspected that the lack of positive criteria on the Islamic investment screening process is due to the lack of interpretation of general evidence in the sources of Islam into some metrics. On the other hand, the ethical investment screening process is a metrics based on the environmental and social problems faced by the society. Hence, Islamic principles prohibit all the negative criteria with a zero tolerance except for some necessities. For example, the prohibition of alcohol in Islam is applied with a zero tolerance for the normal situation except for medical treatment or when dealing with a matter of life and death. Unlike the Islamic principles, the ethical finance exclusion criteria have some tolerance on these attributes in the screening process. For instance, alcohol, adult entertainment, conventional weapons, gambling and nuclear power are considered under the “low tolerance” criteria. The low tolerance criteria allow the firms to generate revenue from those products with the maximum of 15% of the total revenue for ESG criteria whereas the Islamic screening tolerance is set at 5% of total income (AAOIFI, 2017; MSCI, 2021b). Synergies and Contradictions of Social Elements from Shar¯ı’ah Principles In the Islamic code of life, absolute ownership of everything belongs to Allah who has created everything, including wealth in its different forms that are possessed by people. In Islam, communal obligation takes precedence over the individual obligation. Shar¯ı’ah encourages every Muslim to exhibit best practices with the family, neighbourhood, community and 28 “You are the best nation produced (as an example) for mankind. You enjoin what is right and forbid what is wrong and believe in Allah” (Qur’an 3:110).

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the whole society at large. The concept of collective obligation is to ensure social justice, transparency and equity in the treatment of every member of a society (ISRA, 2018). In achieving the aims of Shar¯ı’ah, the concept of Perfection of actions and Continuous Improvement (ihs¯an), Togetherness and Cooperation, Honesty and Sincerity, Altruism and Sacrifice, Justice, Moderation, Balance (m¯ız¯an), Stewardship and Trust (Khil¯afa and Am¯ana), Political Authority (Amarah) and Education (Tarbiyyah) is encouraged (ISRA, 2018; Sardar, 1988, 1989). On social financing, Islam puts the right of every poor person on the rich, so that they must pay the mandatory charity (zak¯ah) to the poor as their obligation from Allah and the right of the needy.29 In fact, if we analyze meticulously we will find that zak¯ah is the only tenet of worship in Islam that ordains the relationship with Allah and people (Haque, 1984). On the voluntary charity, the concept of Endowment (Waqf) and charity (Sadaqah) complement the big concept of charity in Islam. The basis of waqf lies under the hadith of the Prophet: “When a man dies, his acts come to an end, but three, recurring charity, or knowledge (by which people) benefit, or a pious son, who prays for him (for the deceased)” (Sahih Muslim, book 25, hadith 20). Equally important, the philosophical idea behind waqf is to preserve the benefit continuously for a specific group or community. Another voluntary charity in Islam is sadaqah (voluntary alms) is encouraged as a good deed to achieve well-being and righteousness (sal¯ah). Every good deed is considered as sadaqah, this definition is based on the hadith of the Prophet narrated by J¯abir bin ‘Abdullah: The Prophet (PBUH) said “Enjoining, all that is good is a Sadaqah” (Sahih al-Bukhari 6021, book 78, hadith 52). This is also consistent with the objectives of Shar¯ı’ah known as Maq¯asid Shar¯ı’ah mainly cover five essential elements of human life which are religion, life, intellect, lineage and ¯ ur, 2006). wealth (Ibn’Ash¯ Table 3 explores the convergence and divergence of Social elements of ESG and Shar¯ı’ah Criteria. Overall, the social themes of ESG share the same objectives with the principles of Shar¯ı’ah, though the approaches in achieving those objectives might be different. Although we have seen some similarities and

29 “And from their properties was (given) the right of the (needy) petitioner and deprived” (Qur’an 51:19).

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Table 3

Social element of ESG and its Shar¯ı’ah basis

ESG pillars

ESG themes

Shar¯ı’ah basis

Social

Human capital

Islam encourages Muslims to develop their selves, and it is known in Islam that a stronger believer is better than the weaker. An example in the Qur’an: “One of the women said “O my father, hire him. Indeed, the best one you can hire is the strong and the trustworthy”30 Shar¯ı’ah promotes Ihs¯an in every act, the concept of Ihs¯an denotes doing something in the best possible to achieve the excellence and perfection. It is narrated that the Prophet PBUH had said: “Verily Allah has enjoined goodness to everything; so, when you kill, kill in a good way and when you slaughter, slaughter in a good way. So, every one of you should sharpen his knife, and let the slaughtered animal die comfortably”31 One of the most important principles in Islamic management is trustworthiness. The Qur’an has stressed: “O you who believe, do not betray Allah and the Messenger or betray your trust while you know (the consequence)”32 The Shar¯ı’ah has taken an extra mile in emphasizing on caring healthy and safety work environment for employees. It is reported that the Messenger had said: “It is essential to feed the slave, cloth him (properly) and not burden him with work which is beyond his power”33

Product liability

Stakeholder opposition

Social opportunities

Source MSCI ESG research key issue hierarchy (November 2021)

overlapping criteria in the exclusion of some products, Islamic investment is different from the conventional responsible investment. Ethical financing bases its concept on community value or beliefs, which can vary from one community to another. Unlike conventional ethical investment, Islamic investment builds its criteria based on the tenet of Islam. For example, unlike the conventional ethical investment, Islamic investment has the concept of income purification in case the investment involves some elements of impermissibility. The concept requires the Shar¯ı’ah-compliant investors to donate their impermissible income for the purification of wealth. This is based on since the concept is based on the Islamic principles which is mentioned in the Qur’an: “But if you

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repent, you may have your principal – (thus) you do no wrong, nor are you wronged” (Qur’an 2:279). Such concepts do not exist in the conventional ethical investment. More importantly, unlike conventional ethical investments, Islamic investment excludes the conventional financial sector in their screening process which eliminates any element of riba. Responsible investment regards environmental risk, social impact, corporate governance and ethical values as significantly important factors of assessment. On the contrary, Islamic finance has neglected these aspects and merely focusses on the exclusion criteria to avoid investing in nonShar¯ı’ah compliant products. In other words, the Shar¯ı’ah screening is only focussed on whether the output is permissible from the Shar¯ı’ah perspective. Nevertheless, there is a development in Islamic investment for incorporating the sustainability factors into its screening process later known as the Islamic Sustainability Index introduced in 2006. Review of the Islamic investment screening is necessary to rejuvenate the concept and be more consistent with the embedded ethical values of Islam (Wilson, 2004). Synergies and Contradictions of Governance Elements from Shar¯ı’ah Principles The concept of supervision in Islam is known as hisbah, the word hisbah means “sum” or “reward”. Technically, it means to promote proper conduct and to avoid all types of misdeeds or offences. Although the Qur’an envisages that every Muslim has responsibility for the propagation of good and the eradication of evil, the state is empowered to establish arrangements to oversee the implementation of this institution, as decreed the Qur’an: “And let there be (arising) from you a nation inviting to (all that is) good, enjoining what is right and forbidding what is wrong, and those will be the successful ” (Qur’an 3:104). Therefore, the function of the hisbah consists of maintaining public law and order and supervising the behaviour of buyers and sellers in the market with a view to ensure the right conduct. In this regard, the

30 Qur’an 28:26. 31 Sahih Muslim 1955, Book 34, Hadith 84. 32 Qur’an 8:27. 33 Sahih Muslim, Book 27, Hadith 64.

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Prophet himself acted as the first (muhtasib) person responsible for the maintenance of the institutions of hisbah. Subsequently, he appointed some of his companions to perform this duty, including Sa’¯ıd b. Al-‘As in Makkah and ‘Umar b. Al-Khatt¯ab in Madinah. In general, the functions of muhtasib cover the rights of Allah and the people, including responsibilities on moral and legal obligations such as prayers, maintenance of mosques, community matters, market dealings, etc. (Saleh, 2009). At the company level, the concept of hisbah needs to be embraced by all members of the community from shareholders as well as stakeholders (Abd Razak, 2018). To look at the convergences and divergences of the social elements of ESG from Shar¯ı’ah, we have listed down the governance themes and their Shar¯ı’ah bases in the Table 4. In brief, most of the governance aspects of ESG are aligned with the Islamic principles. However, the guiding principles between ESG and Shar¯ı’ah are different. The ESG Corporate Governance Structure comes with the specific metrics of measurement which cover several components of the corporate governance. The key metrics mainly focus on boards, pay, ownership and accounting (MSCI, 2021a). Conversely, the Shar¯ı’ah criteria on governance cover the characteristics and structural elements of governance and not the practical and scoring methodology. Additionally, when it comes to the ethical values of the governance such as transparency and consistency, the Shar¯ı’ah as a religious guideline explains them from a general perspective rather than specific practices as defined in the ESG initiatives. ISRA (2011) explained Table 4

Governance element of ESG and its Shar¯ı’ah basis

ESG pillars

ESG themes

Shar¯ı’ah basis

Governance

Corporate governance

The Prophet said: “All of you are guardians and are responsible for your wards ”34 “O mankind, eat from whatever is on earth (that is) lawful and good and do not follow the footsteps of Satan. Indeed, he is to you a clear enemy”35

Corporate behaviour

Source MSCI ESG research key issue hierarchy (November 2021)

34 Sahih Al-Bukhari, Book 67, Hadith 134. 35 Qur’an 2:168.

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that in comparing the Islamic model with the Anglo-Saxon and European models of governance, the western models are based on rationalism and rationality whereas the Islamic model is based on the tenets of Shar¯ı’ah.

5

Conclusion and Recommendation

The chapter analyzed the basic nature of ESG, Shar¯ı’ah rules and principles and Islamic finance and documented that the ESG and Shar¯ı’ah rules and principles share the same objectives to some extent and the different approaches taken to achieve these objectives. The Islamic financial system attempts to solve the problem from the roots with a lack of areas covered and slow development whereas the western ethical financing concept provides a robust ethical finance framework but are not focussed on the root causes. The objectives of this chapter are to create understanding and awareness on the key similarities and differences on each sub-element of ESG components with Shar¯ı’ah rules and principles, that could be applied practically in Islamic Ethical Finance. This chapter provides imperative information in designing the Islamic ethical framework by analyzing the three concepts of Shar¯ı’ah related to ESG activities, which are Khal¯ıfah, M¯ızan and Ihs¯an to help the Islamic financial industry to encompass its ethical dimension. The Shar¯ı’ah value proposition can be more robust and attractive, Islamic finance practice could apply positive screening approaches covering wider Islamic ethics moving beyond compliance into best practice, consistent with the ValueBased Intermediation (VBI) concept. Given the discussion in this chapter, it would be more feasible if these factors are incorporated into policy that could chart the industry’s future. A proper Shar¯ı’ah compliant framework with ethical values acceptable to all, would require little intervention from the government to drive the market behaviour and help the industry. In the banking industry, the Shar¯ı’ah committees of AAOIFI or SAC BNM need to consider ESG initiatives in their decision-making. Developing a Shar¯ı’ah standards on ethical financing would assist the Islamic banking industry promoting its value proposition while gaining profits. On the capital market side, many initiatives can be made by incorporating both Shar¯ı’ah and ESG. For example, the issuance of green sukuk.

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Not limited to the banking sector, Islamic finance also has an untapped potential on Islamic social finance. Developing a green waqf and empowering zak¯ah recipients through an agriculture-based programmes might be an example of initiatives in Islamic social finance. However, A robust policy framework is needed to foster its development and outreach in real markets. To innovate and explore broader areas of the industry on ESG initiatives in the Islamic finance industry in general requires strong political commitment, research and financial support to achieve the objectives for the survival of this industry in a competitive environment.

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CHAPTER 10

Finance as a Source of Ecological Quality: Islamic Ethics of Environment and Empirical Evidence Muhammad Tariq Majeed

1

Introduction

Achieving high economic growth is a key policy objective of all countries. Thus, evaluating the growth performance of an economy has become an issue of considerable debate and interest since the times of Adam Smith. Economists, social scientists, and political scholars have discovered many growth predictors since the beginning of the industrial revolution in about the 1760s. Consequently, economic growth has been fostered all around the world with dissimilar patterns of growth rates across different groups of countries. However, increasing economic growth rates created another challenge for the world that is environmental loss. That said, the present world is facing two major issues that are achieving high economic growth and maintaining ecological balance. Environmental degradation has become a worldwide threat to humankind

M. T. Majeed (B) School of Economics, Quaid-I-Azam University, Islamabad, Pakistan e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8_10

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and other living creatures because of the increasing accumulation of greenhouse gases (GHGs) in the atmosphere. Industrialization has rapidly grown across countries during the past two centuries. The process of industrialization is largely based on energy use which is fulfilled with conventional resources as they are relatively cheap but environmentally expensive. Consequently, policy makers find it increasingly hard to maintain the trade-off between economic growth and environmental loss. Financial sector has been playing a central role in explaining the economic growth performance of economies and influencing environmental quality. However, the direction of relationships between financial development and environment is neither clear nor certain. Both theoretical and empirical studies predict conflicting conclusions. On one hand, financial development is considered as a panacea for environmental quality because it influences industrialization, research and development, and energy substitution between non-renewable and renewable forms of energy sources. It can attract more environmentally clean projects by supporting investment in research and development (R&D) activities. It can also support investment in clean technologies by relaxing financial constraints for substitution between conventional energy sources and clean energy sources. It can enhance resource efficiency by minimizing financial costs and capital risks. On the other hand, financial development can deteriorate environmental quality by expanding credit facilities for electrical devices, automobiles, and houses. Credit facilities serve to augment the scale effect of the environment because business horizons are expanded, new plants are set up and carbon emissions tend to increase (Zhang & Zhang, 2018). Furthermore, foreign direct investment (FDI) inflows increase in financially developed economies, thereby increasing environmental degradation (Sarkodie & Strezov, 2019). Another strand of the literature has focused on Islamic perspectives of finance in relation to environment and development (Obaidullah, 2018; Solarin, 2019). These studies argue that Islamic finance can play an important role in preserving the environment. This debate has also focused on the role of Islamic finance for linear vs. circular economy. The basic argument is that the financial sector contributed to the linear paradigm under Millennium Development Goals (MDGs). In contrast, it is also argued that the financial sector can play a central role in contributing to the circular economy under Sustainable Development Goals (SDGs).

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Under both paradigms, many empirical studies have explored financial development and the environment nexus, but these studies have certain limitations. These studies largely measure the quality of the environment using carbon emissions (Maji et al., 2017). The carbon emissions are, however, represent just one dimension of the environment (Al-Mulali & Ozturk, 2015). By contrast, ecological footprint (EFP) is a more comprehensive measure of anthropogenic pressure on the ecological system. In addition, these studies generally use one measure of financial development that is a credit to the private sector. Another issue with the existing studies is that they have largely focused on country-specific evidence or regional-specific evidence. There are certain strengths of EFP over other measures of environmental quality. First, it measures the pressure of anthropogenic activities on the environment using diverse forms of environment instead of just using greenhouse gases and is considered as a comprehensive measure of environmental quality. Second, it incorporates the information of various natural resources which are necessary for the production and support of the economy (Katircioglu et al., 2018). It traces the information of ecological imbalances (Castellani & Sala, 2012). It is considered as an efficient measure of depleted natural resource reproduction (Aydin et al., 2019). Fifth, it facilitates the policy makers by providing resource demand and supply information, which is important to manage an efficient resource distribution (Wackernagel et al., 2006). The literature has paid little attention to the developing world including Organization of Islamic Cooperation (OIC) countries. The developing economies are exposed to environmental challenges as compared to the counterpart. Since OIC countries are geographically located within the developing world, they are also facing several environmental challenges and assessment of their environmental issues is also important. Islamic countries have asserted their obligation to protect the environment within the framework of the Organization of Islamic Cooperation. However, some scholars argued that the concerns of OIC countries for environmental protection are not clear. Recently, many OIC countries have demonstrated a rapid social change. Conventional and religious values, culture and environmental concerns are in decline. For instance, some OIC countries are responsible for extravagant consumption of food during the holy month of Ramadan (Saniotis, 2012). Similarly, some OIC countries are questioned for contaminating the image of Islam by

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increasing man-mad environmental issues. Such problems include “the devastation of the Aral Sea in Central Asia, desertification in Sub-Saharan Africa, exhaustion of oil deposits in the Middle East, deforestation, and loss of biodiversity in Islamic countries” (Kula, 2001). This chapter has a number of novel elements. First, it provides comprehensive insights into the financial sector and the environment nexus following mainstream environmental economics and Islamic ethics of the environment. This study also focuses on linear vs. circular economy in relation to the financial sector. Second, it focuses on OIC countries in a comparative setting. Third, on the empirical side, this research uses a comprehensive indicator of environmental quality. Fourth, this study uses three proxies of financial development. Fifth, this study uses a dynamic system generalized method of moments (SGMM) to address the potential problem of endogeneity. The chapter attempts to answer the following research questions: (i) What are the Islamic ethics of the environment? (ii) Does financial development improve environmental quality by lowering ecological footprint? (iii) Does the impact of financial development on ecological footprint vary depending upon the measures of financial development? (iv) Is the effect of financial development on environmental quality different for OIC countries? The rest of the chapter is organized as follows: Sect. 2 provides the review of relevant literature; Sect. 3 presents methodology, data sources and statistical analysis; Sect. 4 provides a discussion on empirical results. Section 5 concludes the chapter.

2

Literature Review

In the recent decades, environmental quality is deteriorating as natural resources are being over exploited and depleted. Moreover, loss of biodiversity, weather variations, species extension, and soil erosion have increased. Such loss is the outcome of diverse anthropogenic activities all over the world. This section explores Islamic ethics of the environment and the role of the financial sector in explaining ecological quality. The section is divided into four sub-sections. Section 2.1 briefly describes the environmental context of Islam. Section 2.2 discusses the links between Islamic finance and sustainability. Section 2.3 highlights environmental concerns in the context of OIC countries. Finally, Sect. 2.4

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provides empirical evidence on financial development and environment in the context of mainstream environmental economics. 2.1

Environmental Context of Islam

Allah, the Almighty, says in the Holy Quran (20:53–54): “He Who has spread out the earth for you and threaded roads for you therein and has sent down water from the sky: With it have We brought forth diverse kinds of vegetation. Eat and pasture your cattle; verily, in this are signs for men endued with understanding.” In effect, Allah has created diverse resources for the use and welfare of human beings. Islamic teachings refer to just and sustainable use of natural resources, whereas abstaining from extravagance and wastefulness. As believers, thus, Muslims are duty bound to achieve a higher level of environmental preservation and conservation of natural resources (OIC Environment Report, 2017). The religion of Islam is the third of Abrahamic religions and shares its religious heritage with Judaism and Christianity. Environmental context of early Islam was characterized by its simplicity and respect for nature. As Islam spread into different continents such as Asia, Africa, and Europe during the seventieth century, it maintained its naturalistic approach. A fundamental feature of early Islam, which has informed Muslims for 14 centuries, is its emphasis on nature. The Qur’an and the teachings of the Prophet (PBUH) are the main sources of Islamic environmental ethos that have been integrated within Islamic jurisprudence. Islamic ecological ethics are based on three founding ideas that are tawhid (Divine unity), khilafah (trusteeship), and akhirah (the hereafter). The main implication of tawhid is that Allah is the creator of the whole universe and that all existence reveals unity in plurality (Dutton, 1996; Foltz et al., 2003; Saniotis, 2004). According to Muslim scholars, “universe is governed and regulated by the principles of unity, balance and harmony that characterize the interactive unifying principle—tawhid” (Saniotis, 2012). It is repeatedly quoted in Quran (14:19–20; 15:85–86; 46:3) that the universe characterizes by proportion, harmony, and beauty, which reflect Divine craftsmanship (Nasif, 1987; Ozdemir, 2003; Saniotis, 2004, p. 101; Wersal, 1995, p. 453). The universe is retained in balance, and it is controlled by the interdependency of ecological systems (Faruqi, 1980, pp. 24–31; Wersal, 1995, p. 453). Therefore, “nature provides a source of inspiration and

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guidance for understanding Divine action in creation. In human terms, tawhid is the basis of human action and thought, penetrating every dimension of subjective and social life” (Shariati, 1979). Stewardship (Khilafah) is the second source of Islamic environmental ethics (Idris, 1990; Khalid & O’Brien, 1992). The Qur’an declares humans as stewards of Allah’s creation. Behold, the Lord said to the angels: “I will create a vicegerent on earth” (Qur’an 2:30). Moreover, humans need to abstain from mischief (actions leading to the corruption of the environment). “Do no mischief on the earth after it hath been set in order, but call on him with fear and longing in your hearts: for the Mercy of God is always near to those who do good” (Qur’an 7:56). The importance of ecology in Islam is endorsed by the fact that oneeighth of the Qur’an urges Muslims to mediate on nature. Khalid (1996) highlights that the concept of stewardship implies that humans are friends of the earth, not its masters. The third concept of Islamic environmental ethics is belief in hereafter life. It implies that humans are not only obliged as Allah’s steward on the earth, but also would be held accountable in the hereafter if there is any straying. “Each generation of humans is obliged to improve the condition in which preceding generations have left the earth. No generation has a right to pollute the earth in a manner that depletes its resources and degrades its biological systems” (Weeramantry, 1988, p. 61). Scholars maintain that “humans have the rights and privileges of living from the earth in a sustainable manner” Zaidi (1981, p. 35), Faruqi (1980, pp. 30–31), and Ateshin (1989, p. 179). Qur’an and prophetic traditions explicitly recommend a criterion for responsible human trusteeship of the earth. Islam, as a major world religion has been under-represented in contemporary environmental debates. Foltz (2000) considers environmental problems in the Muslim countries as an outcome of social injustice that is ubiquitous throughout the world. Muslim scholars consider usury-based banking system responsible for environmental degradation as this system rewards few at the costs of many. This is because it encourages conspicuous and wasteful consumption. Ecological problems are reflectors of usury-driven global financial structure. According to political Islam, the contemporary environmental issues neither due to increasing population nor biblical misunderstanding, but these problems are outcomes of Western economic principles that have been leading the world economy for a long period (see Kula,

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2001). Scholars have explored Islamic perspectives of economics, law, politics, and architecture. However, environmental concerns of Islam have received least attention (Foltz, 2000). Even Muslim scholars discuss environmental issues generally relate to the Western orientation rather than to the environment itself. Hekmatpour (2017) explores how various dimensions of Islamic teaching and philosophy can contribute to protecting the natural environment. On one hand, concepts such as “dominion of men over the earth” and “specialness of humankind” can lead to anti-environmental inferences of Islam. Moreover, a number of Islamic governments have shown a bias against environmental stewardship, mainly in cases when governments are authoritarian or placing emphasis on economic development. On the other hand, Hekmatpour (2017) also shows other interpretations of Islamic teaching that are compatible with environmental stewardship. Islamic Mysticism (Sufism) provides a spiritual context for environmentally conscious action. Aboul-Enein (2018) explores references from the Quran to explain the importance of the environment in Islamic literature. “A total of 88 verses in 42 Quranic chapters were identified with a considerable emphasis placed on the importance of water resource management and water conservation, environmental justice, plant conservation, biodiversity, sustainability, and environmental stewardship. These results suggest that the Holy Quran could serve as best medium and educational resource for environmental health interventions in diverse populations, especially in Muslim communities and for improving and maintaining a healthy environment.” Helfaya (2018) reveals that seven environmental thematic groups have been promoted in the Quran that are human beings, water, air, land, plants, animals, and other natural resources. These seven identified themes have many ethical aspects such as the responsibility to use not abuse. Each of these elements has many implications for business practice such as abolishing abuse of women and child labor, reducing wastewater, decreasing air pollution and noise, and preventing exploitation of natural resources. In a recent study, Abdelzaher (2019) advances the extant literature from the belief level of Islamic teaching related to ecology to the action level by addressing questions such as: can we take our belief of “Eco-Islam” to actually guide behaviors and outcomes. Environmental thematic groups in the context of Islamic perspectives can be categorized as follows:

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Human Beings Human beings are discussed in many verses of the Quran. The discussion is based on human beings as a resource or/and as its role played in environmental protection. Being a part of the universe, whose elements support each other Human beings are the representative of Allah, who is blessed with the power to think and decide. They follow the commands and path directed by Allah. Human beings are privileged over all other creations by Allah, they are blessed therefore they are honored and followed (Kader et al., 1983): “Verily we have honored the children of Adam. We carry them on the land and the sea, and have made provision of good things for them, and have preferred them above many of those whom We created with a marked preferment ” (Qur’an 17:70). Human life occupies an important place in the religion Islam and is considered very sacred therefore protected and respected (Deuraseh, 2009; Zinkin, 2007). Termination of human life unjustly, to take another life, or to end one’s life (no matter what the conditions are) is prohibited and is forbidden by God as a human being is a “symbol of Divinity” (Abou El-Fadl, 2003): “… whosoever killeth a human being for other than manslaughter or corruption in the earth, it shall be as if he had killed all human beings, and whoso saveth the life of one, it shall be as if he had saved the life of all human beings …” (Qur’an 5:32). Furthermore, the purchase and sale of products harmful to human health (such as cigarettes, alcohol, and gambling) are prohibited in Islam: “They question thee about strong drink (wine) and games of chance (gambling). Say: In both is great sin, and (some) utility for men; but the sin of them is greater than their usefulness…” (Qur’an 2:219). Human beings being an important element of the environment has the responsibility to protect each other. The preaching of the Quran emphasizes that the rich and powerful members of the society need to take care of the needy and weak people no matter from which religion they belong to. To help and look after orphans the God says: “Give unto orphans their wealth. Exchange not the good for the bad (in your management thereof) nor absorb their wealth into your own wealth. Lo! that would be a great sin” (Qur’an 4:2). The Quran also depicts the balance between the rights, duties, and responsibilities of men and women. However, men are responsible for protecting children and women: “Men are in charge of women, because Allah hath made the one of them to excel the other, and because they spend of their property. So good women are the obedient, guarding in secret that which Allah hath guarded …” (Qur’an 4:34).

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Water The importance of water being a necessity of life is emphasized by the Quran as well as by the Prophet Muhammad (PBUH). Therefore, it is the duty and responsibility of the Muslims to conserve and use water more efficiently without wasting it (in the best possible way). In the Quran, water is mentioned many times in terms of its importance as a resource, usage, and benefits. Quran also emphasizes the care of this resource. Therefore, the importance of water has been highly emphasized in the Quran as it is considered as the basis and origin of life: “… and we made every living thing of water …” (Qur’an 21:30). Water is required for survival and continuity of life of human beings, animals, plants, and all creatures: “O mankind!… And thou (Muhammad) seest the earth barren, but when We send down water thereon, it doth thrill and swell and put forth every lovely kind (of growth)” (Qur’an 22:5). Human beings are reminded to be thankful and realize the importance of water and have been warned that its substitute cannot be provided by anyone and it does not have an alternative if it is vanished (Quran 56:68–70). Air For the continuity and existence of life, air is important: as all living creatures use air to breathe. The discussion about air can be seen in terms of its usage and its value as a resource that should be taken care of. The Quran also sheds light on the benefits of air for humans and their survival (Bagader et al., 1994). As also highlighted by Kader et al. (1983) that wind helps in pollination and movement of clouds which results in rain. God says, “And We send the winds fertilizing, and cause water to descend from the sky, and give it you to drink. It is not ye who are the holders of the store thereof” (Qur’an 15:22). Islamic laws always explain the importance and usage of different resources. Furthermore, it is also proved through biological laws that air is an essential component required for life maintenance. Therefore, the use of every resource in such a way that does not endanger its quality or quantity is emphasized and Muslims are ordered to follow these practices. Activities that lead to deterioration of air quality through pollution and damaging the functions provided by the resource are highly forbidden (Quran 40:64). Human activities have led to disbalance in the functioning of this world system. The damage of the Ozone layer over Antarctica is caused by refrigerants. The importance of atmosphere has been

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mentioned as: “And we have made the sky a roof withheld (from them). Yet they turn away from its portents ” (Qur’an 21:32). God has protected the earth by the layer of atmosphere however this layer is damaged due to human activities. Islam considers that the damage caused should be reversed and efforts should be made by organizations at the global level to restore the original quality of the resource. Land Land also occupies a special place for the survival of life on earth. In the Quran, its importance has been mentioned as the use of land/soil resources. Quran emphasizes its maintenance as a resource. God has mentioned the usefulness of land in the provision of minerals for humans, animals, and plants and its ability to provide food and vegetation which can also be found in the mountains (Bagader et al., 1994). The land is a home provided by God for all the creatures (Quran 71:17–20). Furthermore, God has made soil fertile to support crops and vegetation which is necessary for all creatures. The mountains are made to hold water and support agriculture as they can hold rain. In the Quran, it is stated that “Have We not made the earth a receptacle, Both for the living and the dead, And placed therein high mountains and given you to drink sweet water therein?” (Qur’an 77:25–27). The land is known as the “mother” of human beings. The prophet Muhammad (PBUH) was quoted as saying: “Preserve the earth because it is your mother”. In this context, God states: “He brought you forth from the earth and hath made you husband it. So ask forgiveness of Him and turn unto Him repentant ” (Qur’an 11:61). Thus, by emphasizing the importance of land and soil, God wants human beings to be thankful for this precious resource and should protect this resource from degradation, pollution, and erosion by floods and winds, respectively. It is the supreme responsibility of the human beings to look after this precious resource and make sure that its productivity is not lost which is important for the survival and existence of life on Earth: to protect the soil, improve abandoned land, or otherwise deny God’s favors and earn punishment by mistreating this non-renewable resource (Bagader et al., 1994; Kula, 2001). Plants Plants being a living resource support survival of human beings and animals. Plants serve as a source of food as stated by God in the Quran, “Let man consider his food: How We pour water in showers, Then split the

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earth in clefts, And cause the grain to grow therein, And grapes and green fodder, And olive-trees and palm-trees, And garden-closes of thick foliage, And fruits and grasses: Provision for you and your cattle” (Qur’an 80:24– 32). Being resource plants are discussed in Quran for their value and usage as a resource and its care is emphasized. Plants provide multiple benefits in protecting land from water and wind erosion to the provision of oxygen along with having medicinal value, use in wax, perfumes, oil, fuel, and a source of energy (Bagader et al., 1994). God says, “Have ye observed the fire which ye strike out; Was it ye who made the tree thereof to grow, or were We the grower? We, even We, appointed it a memorial and a comfort for the dwellers in the wilderness ” (Qur’an 56:71–73). Animals The mercy of God is not just limited to human beings, but it is for all the creatures including animals. There is a special place of animals as mentioned by God in the Quran, “There is not an animal in the earth, nor a flying creature flying on two wings, but they are peoples like unto you” (Qur’an 6:38). Animals being an important environmental resource are discussed in many verses in the Holy Quran for their benefits as a resource and their care is emphasized. Animals provide hair, wool, and leather to human beings. They are used for the manufacturing of medicine, perfumes, and also used for transportation (Bagader et al., 1994; Quran 16:5–8). Animals are discussed as a source providing joy, enjoyment, and pleasure along with peace of mind to human beings as discussed in the Quran and enhance their performance (Bagader et al., 1994; Kader et al., 1983). God says, “And wherein is beauty for you, when ye bring them home, and when ye take them out to pasture” (Qur’an 16:6). Animals worship God and bow before him as they are created with this inbuilt nature (Qur’an 22:18). As human beings are not the only ones who worship God, other creatures also worship God therefore they deserve care, protection, and respect (Bagader et al., 1994; Kula, 2001). If not taken care of, human beings will be responsible for the loss of this resource (Bagader et al., 1994; Kula, 2001); “Destruction hath appeared by land and by sea on account of what men’s hands have wrought, that it might make them taste somewhat of the fruit of their doings, that haply they might turn to God” (Qur’an 16:40). Since 300 BC research has been conducted on animals due to their medicinal value. Animal-based research led to the discovery of insulin for diabetes treatment (Novo Nordisk, 2008). The pharmaceutical industry

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conducts experiments on animals for the development of new drugs and this experimentation has been a concern among different organizations (National Animal Rights Organisation, Lush, REACH, and Charity Pot). Islam dislikes the unkind behavior toward all creatures including animals and this behavior becomes the reason for a person going to Hell. As mentioned by the prophet Muhammad (PBUH) that God forgives human beings when they show mercy toward animals as was the case of providing water to a thirsty dog. The prophet was asked “O Prophet of God, do we get rewarded on humane treatment of animals?” He said, “There is a reward in doing good to every living being.” The prophet Mohammed described God’s punishment of a women who was sent to Hell because of a cat she kept locked up, neither feeding her nor setting her free to feed herself. With regard to slaughtering animals in Islam, Muslims should slaughter the animal and not use other methods to kill them. The prophet Mohammed said, “If someone slaughter an animal let him slaughter very well, let him sharpen his knife and let the animal rest ”. Muslims have been instructed not to slaughter one animal in front of the other. Even at Eid Aldha, Muslims are asked to follow the mentioned path. The meat of the slaughtered animal on this religious festival is divided into three equal parts: one part is for the owner, the second part for the relatives, friends, and neighbors and the third part is for the poor people. Other Natural Resources Human beings are provided with several natural resources and prohibited from their exploitation. Among these natural resources sun, moon, stars, hills, day, and night are discussed in many verses of the Quran. Most of the discussion is based on their use as a resource. Further, the discussion emphasizes their care and maintenance as a resource. In this regard God says, “Allah it is Who raised up the heavens without visible supports, then mounted the Throne, and compelled the sun and the moon to be of service, each runneth unto an appointed term; He ordereth the course; He detaileth the revelations, that haply ye may be certain of the meeting with your Lord” (Qur’an 13:2; see also, 10:67; 16:12; 25:47). God also says: “And we have made the sky a roof withheld (from them). Yet they turn away from its portents. And He it is Who created the night and the day, and the sun and the moon. They float, each in an orbit ” (Qur’an 21:32–33; see also, 15:19; 21:79). Stars serve as a guide for human beings during the night as

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explained in the Quran (Qur’an 6:97), the sun and moon help to measure time and year (Quran 10:5) and serve as a source of light (Qur’an 71:16). Although those resources benefit humankind, however, their desire for exploration leads to a significant negative impact such as outer space exploration influence the density construction and chemical composition of moons atmosphere. This leads to unintentional terraforming of another world. The use of modern technologies including nuclear arms competition of the US and Soviet Union increases threats for space (www.nasa.gov). The Islamic values promote the sustainable use of natural resources and prohibit their overexploitation (Qur’an 2:29; 6:97; 13:2; 21:16; 45:13; 55:5–9). All these values and conservation of natural resources should be practiced and be a part of the business programs to ensure their availability and sustainability. Figure 1 summarizes a flow chart of environmental beliefs and behaviors in the context of Islam. 2.2

Islamic Finance and Sustainability

Islamic finance is considered as “ethical capitalism,” and it represents financial systems adhering to “Islamic laws.” It follows the rules of equity, fairness, and justice which are necessary for environmental sustainability (Solarin, 2019). Islamic banks are increasingly paying attention to green financing such as promoting renewable energy sources containing wind, hydropower, and solar energy (Obaidullah, 2018). Moreover, financial institutions support many other green initiatives such as low-carbon technologies, water preservation, and mass transit. Provides a comprehensive discussion on the possibilities of achieving sustainable development goals through the medium of financial instruments in the light of Islamic principles. Achieving high economic development and wellbeing (human development) remains the fundamental objective of the economies. However, from the Islamic point of view, the debate on this topic emerged as a burning issue after the new initiatives taken by Islamic Development Bank (IDB) in 2006 when they set a new agenda for comprehensive human development (CHD). Later, following this agenda, many Islamic economic scholars started their research on this particular area and concluded that CHD can be achieved if initiatives are taken to protect five human necessities, namely, religious faith, life with dignity, progeny and future generations, responsible mind and intellect, and wealth and graceful sustenance.

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Islamic Beliefs and Behaviors WHY should Human beings care about the Environment?

Tawheed “Allah is the heritage of Heavens and Earth, and Allah is informed of what you do” (Qur’an 3:180)

Khalifa

Maslahah

“Lo; I am about to place a viceroy on Earth” (Qur’an 2:30)

“Avoiding harm is paramount to achieving uƟlity”, “no harm should be inflicted or reciprocated in Islam” said by Prophet Muhammad (PBUH)

WHAT is the Environment and Human’s role in the Qur’an? Environment is the creaƟon of God

Human Water

Environment is sustained by God

Air

User

Land

Environment is a sign of God

Plant Environment is a sign of God

Animals

Environment is the witness

Other Natural Resources

Carer

HOW should Human beings care about Environment? Qadar

Fig. 1

WasaƟya

Muhasaba

Tawadu

Environmental beliefs and behaviors

Other than national governments, international agencies also take part in economies’ development and introduce their development plans. As, initially, MDGs were introduced by the UN, but under the “linear economy” framework, they remained unachievable (mainly the MDG-I, the goal of absolute poverty). As in this system (economic and financial), the two vital forces namely environment and faith are extremely neglected,

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which play a sizable role in economies’ development and wellbeing. There are two economic reasons behind this ignorance. First, our linear economy is based on economic and financial systems, which follow the Hoteling’s (1931) principle. This principle serves the interest-based financing for acquiring high profit and wealth. Hence, economic agents largely ignore the role and significant importance of ecosystem/environmental services. With the objective to expand business horizons, economic development, and for earning high profit they destroyed and depleted ecosystem services at a remarkable pace. In other words, our current economic system is functional because of the borrowed future generation resources as we consume and waste more than the earth’s regenerative capacity. Second, the role of faith was highly ignored in MDGs (and in the linear economy). The role of faith was considered a barrier in development, which created a mismatch in the MDGs (national and global goals) and local aspiration (faith-based) objectives. However, in overall economic structure Islamic financing appears only a sub-set of the financing structure, which is not effective in achieving development objectives. Therefore, SDGs were recently developed keeping in view the challenges faced in achieving MDGs. The SDGs provide greater flexibilities in financing methods as compared to MDGs, therefore, this shift is regarded as a “paradigm shift.” Like the world is shifting from “linear economy paradigm” to “ecological/circular economy paradigm” for achieving the sustainable development objectives. Under the circular economy system, significant importance is given to the environment and to the religion Islam. Because religion provides foundation for constructing the basic institutional infrastructure of a society. The religion-based financing particularly, Islamic financing is an important mode of financing for SDGs (involving charities, zakat etc.). Moreover, Islam emphasizes ecological balance and promotes protection and conservation of natural resources. So that resource remains for future generations as well. Broadly, it can be said that the objectives of circular economy and maq¯as.id al-Shar¯ıah are consistent as circular economy incorporated the shariah elements (as they are real objective) which make SDGs and CHD achievable. With these features, “circular economy paradigm” has gained a significant support from the international community and measures are taken to adopt renewable energy resources and ethical banking. Now other than Islamic institutions, the UN and its affiliated institutions are also working

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on the transformation of financial architecture in favor of Shar¯ıah based financing, which provides an invaluable opportunity to Islamic financing. Putting discussion into more practical terms, it can be said that maq¯as.id al-Shar¯ıah (local aspirations), national objectives, and global objectives can be considered as three main pillars of an economic policy in a circular economy. Hence, for the effective policy implementation these pillars are required to operate simultaneously for accomplishing the goal of sustainable development and wellbeing. This is possible with the Islamic financing as it promotes financial inclusion instead of financial exclusion which was the spirit of linear economy paradigm. Because in the MDGs (under the linear economy system) the argument “interest is not riba” was rejected by the local population (that segment of population is excluded) which end up with the policy conflict (in national/global goals and in local aspirations). In the context of new policy design, the requirement would be defiantly broader and Shar¯ıah governance (SG) need to be reformed. In the reformed scope of SG certain things need to be incorporated in the existing scope of SG to implement SDGs successfully. In the reformed SG, different layers of SG, namely, users of services, micro, meso, macro, and level, need to be incorporated. Currently, the focus of SG is on micro level which is a necessary element but insufficient in the current era. The only focus on micro level involves structural risks as it ignores global progress in financial architecture. Therefore, it acts as a barrier in Islamic financing progress. The layer meso level provides flexibility of screening investment opportunities through technology which is aligned with local preferences. Then, under the macro level, the regulatory authorities provide the implementation of effective international practices and provisions of safety nets. At global level, the Islamic financing principles are fixed with international institution standards and norms. In this way, redefining the SG would help to achieve SDGs and CHD. A forementioned discussion suggests that the linear economy is responsible for environmental problems. The interest-based financial system essentially becomes as an engine for driving such a linear economy. In contrast, the circular economy takes care of ecological problems. Nevertheless, Islamic economy can be circular as well as linear economy. Furthermore, Islamic economy can be neither linear nor circular (Fig. 2).

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(a): Islamic Economy is more circular than linear Ecological (circular) economy Paradigm

ConvenƟonal (linear) economy Paradigm Islamic Economy Paradigm

Fig. 2

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(b): Islamic Economy is more linear than circular

ConvenƟonal (linear) economy Paradigm

Islamic Economy Paradigm

Ecological (circular) economy Paradigm

Circular economy: conventional economy vs. Islamic economy

2.3

Environmental Degradation and OIC Countries

According to OIC Environment Report (2017), environmental degradation is a problem of the whole world but relatively its negative effects are more pronounced in developing countries. Being a substantial part of the developing world, OIC member countries are vulnerable to various climate-related challenges. Majority of the OIC member countries is above medium level of environment vulnerability (OIC Environment Report, 2017). In effect, the high environmental vulnerability of OIC countries is attributed to their geographic locations, high dependence on climate sensitive natural resources and low adoptive capacities. Environmental issues of OIC countries pose serious economic and social challenges particularly for the underprivileged and poor population. Kula (2001) argues that some of the Muslim countries are questioned for whether they have contaminated the image of Islam by escalating manmade environmental problems. The problems related to the environment in Islamic countries are considered as the product of social injustice such as lack of awareness of environmental issues (Foltz, 2000), and failing to compliance the principles of Quran and Prophetic teachings (Foltz et al., 2003). Saniotis (2012) explores different aspects of Muslim environmentalism to answer the question that how Islamic environmental ethics influence environmental practices. He concludes that “while Islam provides detailed ethical principles on the environment, the majority of Muslim majority countries show an apparent indifference to environmental issues.”

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Muslim majority countries are going through a rapid social change that challenges conventional cultural norms. Consequently, various sociopolitical tensions have been arisen in many Muslim majority countries. Ecological degradation in various Muslim majority countries is related to social change (Saniotis, 2012). Ismail et al. (2019) explore the different aspects of environmental performance for high-income countries of the Muslim world. Their study provides evidence that the majority of the rich Muslim countries were in the rank of “taking environmental performance as unimportant.” Thus, environmental degradation remains an important challenge in the Muslim world. 2.4

Environment and Financial Development Nexus: Empirical Evidence

The literature on financial development and environment is not yet conclusive. Earlier studies highlighted the role of multilateral banks in affecting the environmental quality. Aufderheide and Rich (1988) argued that World Bank’s financial assistance and mechanism often ignore the environmental impact of the loanable funds and lead to serious environmental concerns. For example, in the case of India, financing the energy capital increased soil erosion, the Grand Bereby rubber project resulted in tropical forestland deterioration and micro-finance for the cotton production led the projected agriculture land useless by exhausting the soil. Similarly, Schmidheiny and Zorraquin (1998) concluded that more often financial institutions encouraged short-term goals and ignore the environmental risks, leading to higher natural resource exploitations. Tadesse (2007) and Kumbaroglu et al. (2008) argued that financial development helps to control pollutant emissions by encouraging the technological innovations in the energy sector. Similarly, Lanoie et al. (1998) and Tamazian et al. (2009) argued that well-developed financial system mainly capital markets help to improve the environment by increasing R&D expenditures on energy efficient technology. Apart from affirmative effects of financial development on environmental quality studies also identified the detrimental effects of financial development on environment. Moghadam and Dehbashi (2018) pointed out undesirable effects of financial development on environmental quality of Iran over the period of 1970–2011. Mesagan and Nwachukwu (2018) also found similar results for Nigeria from 1981 to 2016. Similarly,

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Moghadam and Dehbashi (2018) found out that financial development deteriorates the environmental quality by increasing the industrial activities in Iran over the period 1970–2011. Thus, financial development plays a crucial role in influencing the environmental quality. However, the empirical results of financial development on environmental quality are inconclusive. This chapter contributes to the existing literature by exploiting the more comprehensive indicator of environmental degradation and using three measures of financial development for OIC countries from 1971 to 2017.

3 Data, Econometric Specification, and Methodology 3.1

The Data

The data for this chapter is collected for all OIC countries from 1971 to 2017. The data for some OIC countries was missing and the final data set includes 37 OIC countries. The data for ecological footprint is extracted from Global Footprint Network (2018). The data for the remaining series is collected from World Bank (2018). 3.2

Econometric Specification and Data Description

For empirical analysis, this study uses a standard model, which is followed by many studies (Destek & Sarkodie, 2019). However, the empirical studies use carbon emissions as a measure of environmental degradation, whereas this research uses ecological footprint as a comprehensive indicator of environmental loss. The econometric model can be specified as follows: E F Pi,t = γ0 + γ1 F Di, t + γ2 ECi,t + γ3 G D Pi,t + γ4 U Pi,t + γ5 T radei,t + νi + μt + εit . . . . . .

(1)

Here, t represents the time span of the study from 1971 to 2017 andi represents the cross-sectional units. γ0 stands for the constant term. The term EFP represents ecological footprint, FD shows financial development, GDP measures economic growth, UP represents urbanization and Trade shows the sum of exports and imports as a ratio of GDP. The term

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νi shows country-specific unobservable effects, μt shows temporal effects and εit represents error term. Financial development is measured using three indicators that are “domestic credit to private sector (DCP),” “domestic credit to private sector by banks (DCB),” and “domestic credit financial sector (DCF).” Equations for these measures can be specified as follows: E F Pi,t = γ0 + γ1 DC Pi, t + γ2 ECi,t + γ3 G D Pi,t + γ4 U Pi,t + γ5 T radei,t + νi + μt + εit . . . . . . (1.1) E F Pi,t = γ0 + γ1 DC Bi, t + γ2 ECi,t + γ3 G D Pi,t + γ4 U Pi,t + γ5 T radei,t + νi + μt + εit . . . . . .

(1.2)

E F Pi,t = γ0 + γ1 DC Fi, t + γ2 ECi,t + γ3 G D Pi,t + γ4 U Pi,t + γ5 T radei,t + νi + μt + εit ......

(1.3)

3.3

Construction of the Variables

EFP shows ecological footprint measured in “global hectares (GHA) per person” (see Charfeddine & Mrabet, 2017; Katircioglu et al., 2018). “Ecological Footprint accounts act as balance sheets by documenting for a given population – a household, a district, a city, a region or humanity as a whole – the area of biologically productive land and sea required to produce the renewable resources this population consumes and assimilate the waste it generates, using prevailing technology. It documents the extent to which human economies stay within the regenerative capacity of the biosphere. Overall, it is the sum of built-up land, carbon, cropland, fishing grounds, forest products and grazing land.” The domestic credit to the private sector is measured as % of GDP. “It refers to financial resources provided to the private sector by financial corporations, such as through loans, purchases of nonequity securities, and trade credits and other accounts receivable, that establish a claim for repayment.” The second measure of financial development is “domestic credit to private sector by banks” as % of GDP. “It refers to the financial resources provided to the private sector by other depository corporations (deposit taking corporations except central banks), such as through loans, purchases of nonequity securities, and trade credits and other accounts

10

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239

receivable, that establish a claim for repayment.” Finally, the third measure of financial development is the “domestic credit to private sector provided by the financial sector” as % of GDP. “It includes all credit to various sectors on a gross basis, with the exception of credit to the central government, which is net.” Energy consumption (EC) is measured in terms of “kg of oil equivalent per capita” and it is log transformed. “It refers to use of primary energy before transformation to other end-use fuels, which is equal to indigenous production plus imports and stock changes, minus exports and fuels supplied to ships and aircraft engaged in international transport.” The environmental impact of energy consumption can be positive as well as negative. If efficient use of energy is focussed and its utilization is diverted toward green technologies than its favorable effects can be expected for environmental quality (Stern et al., 2006). If traditional sources of energy such as gas, oil, and coal contribute more in energy consumption then environmental quality is compromised (Majeed & Luni, 2019). Economic growth is measured using the log of “GDP per capita constant 2010 US dollars.” The relationship of GDP with the environment can be explained through “scale, composite and technique effects.” Scale effect refers to high production with the expansion of the economy using traditional inputs. The economy transits from traditional agricultural sector to industrial sector. This effect exerts a negative influence on the environmental quality. Composite effect appears in the next stage of development when the economy transits from manufacturing sector to service sector. Finally, technological improvements support environmental quality by introducing green technologies (Stokey, 1998). Insofar as linear impacts of economic growth are concerned, economic growth results in the expansion of traditional and modern sectors, thereby increasing investment, production, and consumption at the cost of environment. Urbanization is also an important source of environment. It is measured as percentage of total population (UP). “It refers to people living in urban areas as defined by national statistical offices.” Zhang and Lin (2012) and Wang et al. (2016) claimed that urbanization increases the environmental degradation because it increases the energy demand and consumption. However, some studies argue that urbanization contributes positively to environmental quality in the context of high-income nations (Chikaraishi et al., 2015). Furthermore, increasing urbanization also leads to efficient utilization of transportation and space, thereby increasing

240

M. T. MAJEED

economies of scale and improving the quality of the environment (Majeed & Mumtaz, 2017). Finally, trade is considered an important factor of the environmental quality. It is measured as % of GDP and can be defined as “Trade is the sum of exports and imports of goods and services measured as a share of gross domestic product.” The relationship of trade with environment can be described through two hypotheses namely the “race to bottom” hypothesis and the “gain from trade” hypothesis. Where, first hypothesis claims a negative association between trade and environmental quality. Foreign firms use cheap and inefficient technologies in countries with weak environmental regulations and poor institutional frameworks (Solarin & Al-Mulali, 2018). In contrast, second hypothesis claims a positive association between trade and environmental quality. Foreign firms prefer the use of clean technologies because of environmental laws. Moreover, they invest in R&D to promote energy efficient technology. Consequently, the quality of the environment improves in host economies. 3.4

Methodology

The empirical analysis is based on panel data estimators. Baseline results are obtained using pooled ordinary least squares (POLS) estimator. To account for country-specific effects and temporal effects, fixed and random effects models are employed. Finally, to address the issues of endogeneity, system generalized method of moments (SGMM) is also employed to obtain the robust estimates. 3.5

Descriptive Statistics

Table 1 presents the descriptive statistics. The mean value of EFP for full sample is 2.12. Comparatively mean value (2.37) of OIC countries is higher than that of non-OIC countries (1.93). Thus, on average, OIC countries are exerting more pressure on ecological balance. Among OIC countries EFP varies from 0.46 to 16.86, whereas among non-OIC countries EFP varies from 0.43 to 9.54. Table 2 provides correlation matrix of the variables used for estimation. Financial development has positive correlation with ecological footprint in both groups of countries. Comparatively, OIC countries demonstrate high correlation, whereas non-OIC countries show low correlation.

10

Table 1 Variable

FINANCE AS A SOURCE OF ECOLOGICAL QUALITY …

241

Descriptive statistics Obs

Mean

Full sample (OIC and non-OIC) EFP 4087 2.124126 DCP 5051 27.62625 DCB 5062 26.17623 DCF 5034 38.58844 EC 3843 6.682023 GDP 5492 7.618302 UP 6677 43.5975 Trade 5130 74.37175 OIC countries EFP 1799 2.37039 DCP 2098 25.4317 DCB 2102 24.69403 DCF 2109 37.77774 EC 1658 6.870777 GDP 2148 7.644323 UP 2632 46.17416 Trade 2143 72.41841 Non-OIC countries EFP 2288 1.930495 DCP 2953 29.1854 DCB 2960 27.2288 DCF 2925 39.17297 EC 2185 6.538795 GDP 3344 7.601587 UP 4045 41.92092 Trade 2987 75.77315

Std. dev

Min

Max

1.899563 23.89327 22.0305 34.91871 0.9983583 1.161523 21.83436 37.55457

0.428228 0.004621 0.004621 −114.694 2.260188 4.880116 2.97 0.020999

16.8557 166.504 166.504 333.987 9.99695 11.64116 100 375.379

2.521474 22.19626 21.64042 37.67454 1.229883 1.391777 22.41096 40.07387

0.46472 0.402581 0.402581 −114.694 3.769542 4.880116 5.861 0.020999

16.8557 158.505 154.892 333.987 9.99695 11.64116 100 375.379

1.167518 24.91562 22.24711 32.78249 0.7471255 0.9855188 21.28678 35.57842

0.428228 0.004621 0.004621 −79.0924 2.260188 5.097565 2.97 0.167418

9.49987 166.504 166.504 248.901 8.687553 9.920045 100 311.354

Figure 3 suggests that 58% EFP belongs to the developed world. Whereas, 23% of EFP belongs to OIC countries and 19% belongs to nonOICs. Thus, these are the OIC countries which are contributing more to global EFP in comparison to the non-OIC developing countries. Figure 4 shows the “distribution of domestic credit to private sector” over the study period. It suggests that 20% of DCP belongs to OIC countries and 24% belongs to non-OIC countries. Likewise, Figs. 5 and 6 indicate a similar pattern of financial development in terms of “domestic credit to private sector by banks” and “domestic credit to private sector by financial sector.”

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M. T. MAJEED

Table 2

Correlation matrix EFP

DCP

Full sample (OIC and non-OIC) EFP 1.0000 DCP 0.2767 1.0000 DCB 0.2880 0.9608 DCF 0.1337 0.8282 EC 0.8060 0.3882 GDP 0.7216 0.3636 UP 0.6295 0.2580 Trade 0.3985 0.2805 OIC countries EFP 1.0000 DCP 0.3308 1.0000 DCB 0.3481 0.9946 DCF 0.1776 0.8263 EC 0.8448 0.3827 GDP 0.7888 0.4389 UP 0.7290 0.4956 Trade 0.5070 0.5570 Non-OIC countries EFP 1.0000 DCP 0.2734 1.0000 DCB 0.2385 0.9427 DCF 0.0988 0.8318 EC 0.7300 0.4323 GDP 0.6267 0.3125 UP 0.5512 0.0894 Trade 0.2045 0.0694

DCB

DCF

EC

GDP

UP

Trade

1.0000 0.7915 0.3758 0.3563 0.2529 0.3212

1.0000 0.2192 0.2132 0.1790 0.0929

1.0000 0.8380 1.0000 0.7296 0.8277 1.0000 0.3784 0.3017 0.2952 1.0000

1.0000 0.8218 0.3997 0.4537 0.5046 0.5576

1.0000 0.2043 0.3025 0.3830 0.2938

1.0000 0.9130 1.0000 0.8399 0.8744 1.0000 0.5202 0.4276 0.5046 1.0000

1.0000 0.7717 1.0000 0.3656 0.2566 0.2619 0.1299 0.0435 0.0170 0.1041 −0.0793

1.0000 0.7202 1.0000 0.6145 0.7868 1.0000 0.1673 0.1411 0.0824 1.0000

Figure 7 represents ecological footprint distribution across OIC countries according to their development levels. The EFP distribution is quite uneven as more than 60% of EFP belong to high-income OIC countries. The 19% of EFP share comes from upper middle-income OIC countries. The remaining 20% contribution comes from low middle-income and low-income OIC countries. It implies that 80% environmental degradation in terms of high EFP is associated within high-income OIC countries. Figures 8, 9, and 10 demonstrate financial development of OIC countries according to their income levels. The major share of financial development, 60%, belongs to high and high middle-income OIC countries.

10

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243

19% Developed OIC

23%

58%

NOIC

Fig. 3 Ecological footprint (Source Author’s own analysis)

24%

Developed 56%

20%

OIC NOIC

Fig. 4 Domestic credit to private sector (Source Author’s own analysis)

Figure 11 represents the time trend of EFP for OIC and non-OIC countries. In the case of OIC countries, EFP remained stagnant during 1970s and increased during 1980s. Overall EFP is increasing in every successive decade, where, during a specific decade the EFP rises gradually.

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M. T. MAJEED

23%

Developed 56%

OIC NOIC

21%

Fig. 5 Domestic credit to private sector by banks (Source Author’s own analysis)

24%

Developed 53%

23%

OIC NOIC

Fig. 6 Domestic credit to private sector by financial sector (Source Author’s own analysis)

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FINANCE AS A SOURCE OF ECOLOGICAL QUALITY …

10% UIC

10%

UMIC

19%

61%

LMIC LIC

Fig. 7 Ecological Footprint (income levels) (Source Author’s own analysis)

11% 33% 23%

UIC UMIC LMIC LIC

33%

Fig. 8 Domestic credit to private sector (Source Author’s own analysis)

245

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M. T. MAJEED

11% 34%

UIC UMIC

22%

LMIC LIC

33%

Fig. 9 Domestic credit to private sector by banks (income levels) (Source Author’s own analysis)

In the case of non-OIC countries, EFP exhibited a slow and gradual rising trend over the study period. Figure 12 indicates the time trend for the first measure of financial development. Both groups of countries show similar trend over the study period. In the 1970s, financial development gradually increased, during 1980 it increased with the fluctuating trend and again increased since 2000. Figure 13 demonstrates the time trend for the second measure of financial development. The time trend for the second measure is similar to the first measure of financial development. Figure 14 shows the time trend for the third measure of financial development. This measure demonstrates an N -shaped time trend. In the 1970s, financial development increased, fell since 1985 and again increased from 2000s.

4

Results and Discussion 4.1

Results of Pooled OLS

Table 3 reports the empirical findings for a combined sample of OIC and non-OIC developing countries using pooled OLS. Columns (1–3) report the results for three measures of financial development. Column

10

FINANCE AS A SOURCE OF ECOLOGICAL QUALITY …

13%

22%

247

UIC UMIC

25%

LMIC LIC

40%

Fig. 10 Domestic credit to private sector by financial sector (income levels) (Source Author’s own analysis) 4 3 2 1

Combined

Fig. 11

OIC

2015

2011

2007

2003

1999

1995

1991

1987

1983

1979

1975

1971

0

NOIC

Ecological footprint trends (Source Author’s own analysis)

(1) suggests that 1% increase in DCP as a ratio of GDP leads to 0.005% decline in EFP. This finding suggests that financial development plays an important role in improving environmental quality by lowering the ecological footprint. This finding is consistent with Zhang and Zhang

248

M. T. MAJEED

60 50 40 30 20 10

Combined

OIC

2015

2011

2007

2003

1999

1995

1991

1987

1983

1979

1975

1971

0

NOIC

Fig. 12 Domestic credit to private trend (Source Author’s own analysis) 50 40 30 20 10

Combined

OIC

2015

2011

2007

2003

1999

1995

1991

1987

1983

1979

1975

1971

0

NOIC

Fig. 13 Domestic credit to private sector by banks trend (Source Author’s own analysis)

(2018) who argued that financial development facilitates the process of energy substitution from conventional energy sources to clean energy sources. The effects of the other two measures of financial development are also negative and statistically significant suggesting that all measures of financial development are conducive to improve environmental quality. The results for control variables suggest that the impact of energy consumption on EFP is consistently significant and positive in all columns.

10

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249

60 50 40 30 20 10

Combined

OIC

2015

2011

2007

2003

1999

1995

1991

1987

1983

1979

1975

1971

0

NOIC

Fig. 14 Domestic credit to private sector by financial sector trend (Source Author’s own analysis) Table 3 Results of pooled OLS

Variables

(1)

DCP

−0.00508*** (0.000980)

DCB

(2)

−0.00421*** (0.00110)

DCF EC

1.367*** (0.0472) GDP 0.293*** (0.0475) UP 0.000469 (0.00208) Trade 0.00680*** (0.000710) Constant −9.377*** (0.234) Observations 2391 R-squared 0.671

(3)

1.352*** (0.0478) 0.293*** (0.0481) 0.000581 (0.00210) 0.00681*** (0.000724) −9.311*** (0.235) 2381 0.670

−0.00277*** (0.000657) 1.343*** (0.0466) 0.277*** (0.0470) 0.00150 (0.00206) 0.00619*** (0.000699) −9.136*** (0.227) 2405 0.671

Note Standard errors in parentheses (***p < 0.01, **p < 0.05, *p < 0.1)

250

M. T. MAJEED

This finding suggests that increasing demand for energy consumption is one major reason of increasing EFP in the developing world including OIC countries. The developing world largely relies on conventional sources of energy use that is coal, fossil fuels, and natural gas. This finding is consistent with the existing studies (Al-Mulali & Ozturk, 2015; Siddique & Majeed, 2015). Economic growth is positively and significantly associated with EFP. Economic growth is an indicator of expansion in the economy that generates investment and production opportunities in the economy. That is, the utilization of resources tends to increase at the cost of environmental quality (Majeed, 2018). Similarly, consumption level and pattern also tend to change with increasing income of individuals, putting more pressure on natural results such as water, air, and land. Urbanization also plays an important role in global warming and climate change. The literature suggests diverse implications of urbanization for environmental quality. According to compact city theory, increasing urbanization improves productivity and efficiency of resource utilization. Moreover, urbanization also increases economies of scale enabling efficient utilization of resources and lowers the burden on the environment. Our results suggest that the effect of urbanization is positive but insignificant. Finally, the effect of trade on EFP is positive and significant implying that environmental quality is compromised in an open economy. The increasing trade integration boosts the process of transferring waste and toxic material, thereby deteriorating environmental quality. Trade increases the exploitation of production capacities. Besides, natural resources are over exploited. Trade also enhances competition and environment is deteriorated in the presence of weaker environmental laws. This mechanism is referred as the “race to bottom” hypothesis. Table 4 presents the regression results for OIC (columns 1–3) and non-OIC (4–6) countries, respectively. The results for OIC countries indicate that financial development decreases ecological footprint. The parameter estimates show that 1% increase in DCP, DCB, and DCF will bring about 0.008 and 0.007 and 0.003 units decrease in ecological footprint, respectively. In contrast, the results for non-OIC countries suggest that DCP and DCB measures of financial development do not exert any significant impact on EFP, whereas, the third measure negatively and significantly influences EFP. These findings infer that the strength of

1.476*** (0.105) 0.348*** (0.102) 0.00125 (0.00464) 0.00918*** (0.00156) −10.62*** (0.392) 1001 0.725

−0.00705*** (0.00246)

(2)

Standard errors in parentheses (***p < 0.01, **p < 0.05, *p < 0.1)

Observations R-squared

Constant

Trade

UP

GDP

EC

DCF

1.462*** (0.106) 0.354*** (0.102) 0.00163 (0.00465) 0.00944*** (0.00156) −10.59*** (0.391) 1001 0.725

−0.00758*** (0.00239)

DCP

DCB

(1) OIC

−0.00282** (0.00141) 1.483*** (0.106) 0.332*** (0.100) 0.000878 (0.00467) 0.00757*** (0.00141) −10.49*** (0.393) 1012 0.724

(3)

Results of pooled OLS for OIC and Non-OIC countries

Variables

Table 4

0.954*** (0.0457) 0.195*** (0.0427) 0.00477** (0.00188) 0.00311*** (0.000663) −6.052*** (0.277) 1390 0.566

−0.00142 (0.000899)

(4) Non-OIC

0.946*** (0.0454) 0.193*** (0.0433) 0.00487** (0.00190) 0.00308*** (0.000669) −6.000*** (0.272) 1380 0.566

−0.000980 (0.00103)

(5)

−0.00210*** (0.000618) 0.971*** (0.0437) 0.190*** (0.0418) 0.00455** (0.00181) 0.00278*** (0.000666) −6.041*** (0.253) 1393 0.570

(5) 10 FINANCE AS A SOURCE OF ECOLOGICAL QUALITY …

251

252

M. T. MAJEED

financial development in influencing environmental quality dissipates in the case of non-OIC developing countries. 4.2

Results of Fixed Effects

In the presence of cross-sectional heterogeneity, the results of OLS lead to biased analysis. To address this issue, alternative estimators of fixed effects and random effects models are used. Tables 5 and 6 provide the results of fixed effects for the combined sample and separate samples for OIC and non-OIC countries, respectively. The fixed effects approach assumes heterogeneous intercepts for all cross-sectional units to control for the cross-sectional time-invariant differences. The results for combined sample represent mixed evidence. The effect of DCP is insignificant, the effect of DCB is positive and significant and the effect of DCF is negatively significant. This finding suggests that the mixed analysis of OIC and non-OIC country does not provide a clearer picture of the relationship Table 5 Results of fixed effects for full sample

Variables

(1)

DCP

0.000286 (0.000715)

DCB

(2)

(3)

0.00132* (0.000790)

−0.00170*** (0.000467) EC 1.074*** 1.070*** 1.101*** (0.0594) (0.0598) (0.0586) GDP 0.267*** 0.243*** 0.290*** (0.0459) (0.0478) (0.0438) UP −0.00581*** −0.00567*** −0.00597*** (0.00187) (0.00188) (0.00187) Trade −0.000289 −0.000471 −0.000228 (0.000578) (0.000580) (0.000567) Constant −6.602*** −6.411*** −6.878*** (0.357) (0.367) (0.328) Observations 2391 2381 2405 R-squared 0.308 0.303 0.308 Number of 89 89 89 id DCF

Standard errors in parentheses (***p < 0.01, **p 0.1)

< 0.05, *p


INF ISM  =>IPI ISM  =>NEER ISM  =>UNEMP INF  => ISM IPI  => ISM NEER  => ISM UNEMP  => ISM BANK  =>INF BANK  =>IPI BANK  =>NEER BANK  =>UNEMP INF  => BANK IPI  => BANK NEER  => BANK UNEMP  => BANK

0.01

Medium term 0.05

1.00

1.221 1.210 2.338 1.013 1.004 1.140 6.691*** 6.647*** 1.157 0.959 0.956 10.724*** 2.509* 2.505* 3.268** *** *** 5.324 5.321 1.302 0.008 0.010 2.159 1.172 1.152 0.041 11.239*** 11.216*** 2.022 0.819 0.803 3.528** 8.451*** 8.488*** 2.758* 1.896 1.906 1.973 2.467* 2.476* 3.391** 11.667*** 11.629*** 1.430 1.862 1.882 1.553 5.501*** 5.472*** 0.022

Short term 1.50

2.00

0.076 1.031 1.551 1.453 0.120 5.813*** *** 7.923 0.127 1.524 1.227 0.440 2.995* 1.842 3.208** 1.419 2.910* 0.733 1.839 5.313*** 10.857*** 2.080 0.837 5.507*** 2.261 0.407 0.641 0.536 0.307 0.471 0.284 1.011 3.590**

2.50 0.216 3.085* 3.478** 4.173** 3.067* 0.878 9.363*** 0.304 0.975 0.827 0.905 4.092** 0.945 3.875** 4.323** 0.733

Note In VAR model, optimal lag length is found three where there is no auto-correlation. Johansen co-integration test allows us to test relation between variables in the long run. In this test (2, N−2p) is degree of freedom and F table is used. *** , ** and * show causality relation between variables in significance levels, 1% 1 (4.895), 5% (3.116) and 10% (2.37), respectively, for each frequency domain (ωi ) 0 and π.ω  (0, π)

banks in the exchange rate market also can influence nominal exchange rate. The influence of banking system on unemployment and industrial production index exists in the longer time periods via credit channel. Increasing stability affects credit amount given by banks positive and increases investments. Increasing investments create job opportunities. This process takes some time. Islamic banks, on the other hand, do not create an inflationary money supply due to its creation mentality. Islamic banks do not trade money but use it as a medium of exchange. They strictly make sure all transactions to be backed by real assets and do not extend loans in hard cash. They buy products and sell/rent them to their clients through Murabaha/Ijara contract. In some cases, Islamic banks also become a partner with their clients through Mudarbah/Musharkah contract.

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However, Islamic banks affect unemployment rate and industrial production index in a long time via channel explained above for banking system. Similarly, Islamic banks make transactions in exchange rate markets and affect the nominal exchange rate. We also test the existence of uni-directional causality running from macroeconomic variables to banking financial stability. The inflation rate affects both of them in the short run, but the statistical significance of causality is low. The reason for causation linkage might be that increasing inflation rate affects liquidity and capital adequacy negatively. So, it decreases stability of financial system. Similarly, industrial production index affects both banks’ financial stability in the short and long run. It might be because of the relation between industry and banks in the context of credit and/or Islamic partnership models. Nominal exchange rate has also the same effect on binary. It affects banks’ balance sheet in the long run. That is why causation linkage is valid only in the long run. Different from other indicators, unemployment induces a change in the whole banking system’s stability in the short and long run. But it does not have any significant effect on Islamic banks’ stability. This may be due to the credit relation between workers and banks. An increase in unemployment rate would mean decreasing loan re-payments and it would reduce asset quality and so financial stability of banks. On the other hand, due to the working principle of Islamic banks, it does not have any effect on the stability of Islamic banks. In the second step, we employ rolling windows causality analysis developed by Balcilar et al. (2010) which allows us to find exact dates when causation linkage appears. Graphs of each causality test are presented in the appendix to save place. According to the results, there is a uni-directional causality running from Islamic banks’ financial stability and inflation rate in only between 2014:M09 and 2015:M06. In the same timeframe, Islamic banks’ financial stability is effective on nominal exchange rate. Results mean that Islamic banks’ stability is effective on monetary variables just in three quarters. Uni-directional causality running from Islamic bank financial stability index to unemployment occurs in a quarter in 2016 and 2017, three quarters in 2019. Unidirectional causality running from Islamic bank financial stability to industrial production index occurs in only the last quarter of 2019. In the last quarter of 2019, unemployment and industrial production index are affected by the Islamic bank stability index.

14

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343

Causation linkage between inflation rate and whole banking financial stability index occurs in only 2017 for five months runs from stability index to inflation rate. Similarly, the banking stability index affects nominal exchange rate in a quarter of 2017. Index affects industrial production index in 2016, 2018 and 2019. The total duration is nearly five quarters. Index affects unemployment rate in only 2015 and 2017 for three quarters.

4

Conclusion

In this study, we investigate the relation between financial stability of banking system/Islamic banking system and macroeconomic performance of the Turkish economy in the aftermath of the end of quantitative easing program of Federal Reserve in May 2013. By doing so, we compare the stability of both banking system and Islamic banking system and also the effects of banking systems on macroeconomic variables. According to comparison of each type of banks about their basic stability ratios, such as liquidity, asset quality, capital adequacy, and profitability, it is possible to say that Islamic banks have some superiorities over the conventional banking system. On the other hand, Islamic banks are not profitable as much as conventional banks. Moreover, different from Islamic understanding, customers of Islamic banks are not loyal to their loans. The ratio of NPLs to total credits is so high compare to conventional banking system. When we compare financial stability index built in the study, both indexes move together until 2016, then Islamic banking financial stability index follows upward trend while other follows a downward trend. That means Islamic banking system follows a more stable path after 2016 compared to conventional banking system. In the second section of the analysis, we try to investigate the effect of financial stability of each bank types on the Turkish economy. To do this, we employ various advanced causality analysis methods. According to analysis results, stability of Islamic banks is effective on real side of the Turkish economy, such as unemployment and industrial production index. On the other hand, it does not affect the inflation rate significantly. The stability of whole banking system is effective on both financial variables and real economic variables. Moreover, the duration of the effect of whole banking system on variables is longer than Islamic banking system. These results may be the cause of working principles of Islamic banks. The basic mentality of Islamic banks is to finance the real side of the

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economy directly. That is why there is uni-directional causality running from stability of Islamic banks to industrial production index and unemployment. On the other hand, a small share of Islamic banks in total banking system can be a reason of non-causality between the stability of Islamic banks and other variables. When we compare macroeconomic indicators’ effects on financial stability of each banking system, it is possible to conclude that macroeconomic changes are effective on both banking systems. Both are affected by economic fluctuations in the Turkish economy.

Appendix Balcilar et al. (2010) Rolling Windows Causality Analysis Results A. Results for Islamic Banks

1

0.8 0.6 0.4 0.2 2014M08 2014M10 2014M12 2015M02 2015M04 2015M06 2015M08 2015M10 2015M12 2016M02 2016M04 2016M06 2016M08 2016M10 2016M12 2017M02 2017M04 2017M06 2017M08 2017M10 2017M12 2018M02 2018M04 2018M06 2018M08 2018M10 2018M12 2019M02 2019M04 2019M06 2019M08 2019M10 2019M12 2020M02

0

ISM≠>INF

INF≠>ISM

10%CV

2014M08 2014M10 2014M12 2015M02 2015M04 2015M06 2015M08 2015M10 2015M12 2016M02 2016M04 2016M06 2016M08 2016M10 2016M12 2017M02 2017M04 2017M06 2017M08 2017M10 2017M12 2018M02 2018M04 2018M06 2018M08 2018M10 2018M12 2019M02 2019M04 2019M06 2019M08 2019M10 2019M12 2020M02

2014M08 2014M10 2014M12 2015M02 2015M04 2015M06 2015M08 2015M10 2015M12 2016M02 2016M04 2016M06 2016M08 2016M10 2016M12 2017M02 2017M04 2017M06 2017M08 2017M10 2017M12 2018M02 2018M04 2018M06 2018M08 2018M10 2018M12 2019M02 2019M04 2019M06 2019M08 2019M10 2019M12 2020M02

14 CONTRIBUTION OF ISLAMIC BANKS ON FINANCIAL …

ISM≠>IPI

ISM≠>NEER IPI≠>ISM

NEER≠>ISM 10%CV

345

1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

10%CV

1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

2014M08 2014M10 2014M12 2015M02 2015M04 2015M06 2015M08 2015M10 2015M12 2016M02 2016M04 2016M06 2016M08 2016M10 2016M12 2017M02 2017M04 2017M06 2017M08 2017M10 2017M12 2018M02 2018M04 2018M06 2018M08 2018M10 2018M12 2019M02 2019M04 2019M06 2019M08 2019M10 2019M12 2020M02

2014M08 2014M10 2014M12 2015M02 2015M04 2015M06 2015M08 2015M10 2015M12 2016M02 2016M04 2016M06 2016M08 2016M10 2016M12 2017M02 2017M04 2017M06 2017M08 2017M10 2017M12 2018M02 2018M04 2018M06 2018M08 2018M10 2018M12 2019M02 2019M04 2019M06 2019M08 2019M10 2019M12 2020M02

346 S. KAYHAN AND T. BAYAT

1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

ISM≠>UNEMP

BANK≠>INF UNEMP≠>ISM

INF≠>BANK

10%CV

B. Results for Whole Banking System

1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

10%CV

2014M08 2014M10 2014M12 2015M02 2015M04 2015M06 2015M08 2015M10 2015M12 2016M02 2016M04 2016M06 2016M08 2016M10 2016M12 2017M02 2017M04 2017M06 2017M08 2017M10 2017M12 2018M02 2018M04 2018M06 2018M08 2018M10 2018M12 2019M02 2019M04 2019M06 2019M08 2019M10 2019M12 2020M02

2014M08 2014M10 2014M12 2015M02 2015M04 2015M06 2015M08 2015M10 2015M12 2016M02 2016M04 2016M06 2016M08 2016M10 2016M12 2017M02 2017M04 2017M06 2017M08 2017M10 2017M12 2018M02 2018M04 2018M06 2018M08 2018M10 2018M12 2019M02 2019M04 2019M06 2019M08 2019M10 2019M12 2020M02

14 CONTRIBUTION OF ISLAMIC BANKS ON FINANCIAL …

BANK≠>IPI

BANK≠>NEER IPI≠>BANK

NEER≠>BANK 10%CV

347

1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

10%CV

0.8 1

0.6

0.4

0.2

0

348

S. KAYHAN AND T. BAYAT

1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

BANK≠>UNEMP

UNEMP≠>BANK

10%CV

References Balcılar, M., Özdemir, Z., & Arslantürk, Y. (2010). Economic growth and energy consumption causal nexus viewed through a boostrap rolling window. Energy Economics, 32, 1398–1410. Bashir, A. (1999). Risk and profitability measures in Islamic banks: The case of two Sudanese Banks. Islamic Economic Studies, 6(2), 1–24. Breitung, J., & Candelon, B. (2006). Testing for short- and long-run causality: A frequency-domain approach. Journal of Econometrics, 132(2), 363–378. Chakroun, M., & Gallali, M. I. (2015). Islamic banks and financial stability: An empirical analysis of the gulf countries. International Journal of Business and Commerce, 5(3), 64–87. Creel, J., Hubert, P., & Labondance, F. (2014). Financial stability and economic performance (SSRN paper). Dickey, D. A., & Fuller, W. A. (1981). Likelihood ratio statistics for autoregressive time series with a unit root. Econometrica, Econometric Society, 49(4), 1057–1072. MacKinnon, J. G. (1996). Numerical distribution functions for unit root and cointegration tests. Journal of Applied Economics, 11, 601–618. Manu, L. P., Adjasi, C. K. D., Abor, J., & Harvey, S. K. (2011). Financial stability and economic growth: A cross-country study. International Journal of Financial Services Management, 5(2), 121–138. Perron, P. (1986). Tests of joint hypotheses for time series regression with a unit root. Cahiers de recherche 8632, Universite de Montreal, Departement de sciences economiques. Smets, F. (2014). Financial stability and monetary policy: How closely interlinked? International Journal of Central Banking, 10(2), 263–300.

CHAPTER 15

Proposing New Islamic Microfinance Model for Sustainable Islamic Microfinance Institution Ascarya and Ali Sakti

1

Introduction 1.1

Background

Islamic microfinance has been applied as primary tools for poverty alleviation, empowerment, dakwah, social inclusion, financial inclusion, graduation, and wellbeing improvement, using Islamic social finance instruments, such as zakat, infaq, sadaqa and waqf, as well as using Islamic commercial finance instruments, such as micro savings, micro-financing, micro investment, micro takaful, payments and transfer. Some examples include Akhuwat in Pakistan (Akhter et al., 2009), Bait-un-Nas’r in India

Ascarya (B) University of Darussalam Gontor, Kabupaten Ponorogo, Indonesia Ascarya · A. Sakti Bank Indonesia Institute, Bank Indonesia, Jakarta, Indonesia e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8_15

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(Irfan, 2020), Social Islami Bank Limited (SIBL) in Bangladesh (Mannan, 2018), Amanah Ikhtiar Malaysia in Malaysia (Othman, 2015) and Baitul Maal wat Tamwil in Indonesia (Adnan & Ajija, 2015; Hasbi, 2015). Islamic microfinance could be operated as charity-based and not-forprofit employing Islamic social financial instruments fully. Meanwhile, Islamic microfinance could also be operated as market-based and forprofit employing Islam commercial finance instruments fully (Obaidullah, 2008). Islamic microfinance could also combine Islamic social finance instruments and Islamic commercial finance instruments forming integrated Islamic social and commercial finance (Ascarya, 2017). One of the classic problems of microfinance institution is double bottom-line to achieve outreach to the poor and financial sustainability simultaneously, which could be conflicting or trade-off, leading to a mission drift (Armendariz et al., 2011), where microfinance has been drifting their mission from social to commercial prioritizing financial sustainability, but leaving the outreach to the extreme poor and poor. However, some empirical studies have also found it to be achievable, such as Bos and Millone (2015). Furthermore, microfinance has even been struggling with triple bottom-line proposed by Zeller and Meyer (2002), where microfinance should achieve not just outreach to the poor and financial sustainability, but it should also achieve welfare impact. Double bottom-line and mission drift problems have not been prevalence in Islamic microfinance, as proven by Purwanto et al. (2018) who found trade-off and correlation between social and financial efficiency among IMFIs in Indonesia, as well as by Tamanni and Haji Besar (2019) using global data who found that IMFIs could achieve double bottom-line simultaneously. Other than those problems, Islamic microfinance institutions (IMFIs), as well as conventional microfinance institutions (CMFIs), have been exposed to another classic problems of financial institutions as intermediary agent who adopt pooling of fund system, where IMFIs collect funds, pool those funds, and then extend these funds for various term-financing using various modes of financing. These problems are associated with fractional reserve banking (FRB) system in banking (Meera & Larbani, 2009). This pooling of fund system would create problems of liquidity and mismatch at the same time. IMFIs in Indonesia have been experiencing these two problems almost constantly overtime, especially in time of Ramadhan and new academic year, where many member-customers

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withdraw their savings. These problems would be escalated when IMFIs struck with the problem of funding. These liquidity and mismatch problems arise due to the absence of the “lender of last resort” for IMFIs (and CMFIs) in Indonesia, and in most other countries, as generally stated by Bordo (1990). When faced with a liquidity problem, Islamic banks could go to Islamic money market to find additional short-term liquidity. If the problem persists, Islamic banks could turn to central bank, as lender of the last resort, to ask for help. Meanwhile, IMFIs (and CMFIs) could not access the Islamic money market, and could not ask the central bank for help. Therefore, assuming that government would not establish the “lender of last resort” for IMFIs, there is a need for IMFIs to find a better IMFI model which sustainable and free from pooling of fund problems. Studies on these topics of mismatch and liquidity problems due to pooling of fund system in IMFI are yet to be found. Most studies focus on the common risks of IMFI, such as Rozzani et al. (2017) who discussed operational risk, credit risk, shariah-compliance risk and reputation risk, or Ab Manan and Shafiai (2015) who discussed financial risk and credit risk. Moreover, studies on the development of a new model for IMFIs have also been limited to the modified current model, such as Integrated Waqfbased Islamic Microfinance Model (IWIMM) by Haneef et al. (2015), which integrate waqf to current Islamic microfinance model, or waqfbased Islamic microfinance model by Abdullah and Ismail (2017), or integrated Islamic social and commercial financial institution by Ascarya (2017). 1.2

Objective

This chapter aims to design and propose new Islamic microfinance model, combining Islamic social finance and Islamic commercial finance, as well as embracing new financial technology, which could ensure the sustainability of Islamic microfinance institution in Indonesia. The remainder of this chapter will be organized as follows. The second section will discuss various models of Islamic microfinance and their features. The third section will describe the required characteristics or features of the new sustainable Islamic microfinance model and then design/propose several sad models. The fourth section will discuss and analyze critically the proposed models and their application, while the last section will conclude and provide some recommendation for the stakeholders.

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2 2.1

Liteature Reviews Islamic Microfinance

Islamic microfinance in short can be viewed as a combination of microfinance best practices, Islamic approach to poverty alleviation and Islamic norms, using blended charity (such as zakat, infaq, waqf, and qardh hassan) instruments to fulfill basic needs and empowerment, as well as for-profit instruments for development and expansion (Obaidullah, 2008). Microfinance best practices, according to CGAP (2004) could include: (1) poor people also need various financial services, but in much smaller scale; (2) microfinance is an effective tools for poverty alleviation; (3) microfinance to serve the poor is built integrated with the national financial system; (4) microfinance should be able to pay for itself and/or collect charity; (5) microfinance is built permanently to collect deposits, which will be extended as loans, as well as to provide various financial services; (6) microcredit may not be the answer, and needs to be complemented with other support facilities; (7) ceilings on interest rates could prevent microfinance institutions to cover their costs; (8) government should provide supporting policy environment; (9) donor funds should complement private capital, not compete with it; (10) donors should focus their support on building capacity, to resolve the shortage of strong institutions and managers as the man bottleneck; and (11) microfinance works best when it measures and discloses its performance. Islamic approach to poverty alleviation (Obaidullah, 2008) could include: (1) charity; (2) economic empowerment; (3) debt avoidance; (4) cooperation and solidarity; (5) family cohesiveness; and (6) Shariah compliance of contracts. Meanwhile, Islamic norms mean that all must be conducted in accordance with Shariah principles. The poor as mustahiq is eligible to receive zakat to cover his/her basic needs through consumptive zakat program, while he/she is also eligible to receive qard hassan (using zakat or infaq) combined with skills improvement and technical assistance through productive zakat program. When he/she has been graduated from this program, he/she has been out of poverty and could not receive zakat anymore, so that to finance his/her micro-enterprise, he/she should be provided with commercial Islamic micro-financing through Islamic microfinance institution (IMFI) using various Islamic mode of financing. Therefore, there are in general three types of Islamic microfinance, namely: (1) charity-based or social Islamic microfinance; (2) profit-based

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or commercial Islamic microfinance; and (3) integrated social-commercial Islamic microfinance. Obaidullah (2008) described charity-based or social Islamic microfinance (S-IMF) and profit-based or commercial Islamic microfinance (C-IMF), while Ascarya (2017) described integrated socialcommercial Islamic microfinance (ISC-IMF). S-IMF collects Islamic charity or sadaqa, especially zakat, infaq and waqf. Zakat will be disbursed to the poor or mustahiq in the form of consumptive program and productive program, infaq will be used to finance productive program, including skills training, qardh hassan financing, technical assistance, while waqf would be used to finance various social waqf facilities, especially for the poor, such as free education and free healthcare. C-IMF collects deposits, especially savings and investment deposits, extends micro-financing using various mode of financing, as well as provides various Islamic financial services, such as transfer, bill payments, micro takaful, etc. meanwhile, ISC-IMF combines S-IMF and C-IMF within one Islamic microfinance institution. Mustahiq will be served in S-IMF division, while others, especially micro-small enterprises (MSEs) will be served in C-IMF. In addition, ISC-IMF usually has graduation program to assist the poor to get out of poverty, moving from S-IMF to C-IMF in stages. 2.2

Financial Technology

The emergence of financial technology (fintech) has disrupted all financial sectors, including Islamic microfinance. Conventional fintech have also began to emerge to serve the financial needs of unbankable people, including MSEs. Several Islamic fintech have also been established. As of April 2020, there have been 161 registered fintech companies, including 13 Islamic fintech companies, established in Indonesia serving mostly micro, small and medium enterprises (MSMEs) for their financing needs (OJK, 2020). Islamic microfinance institutions (IMFIs) have recognized their needs to use fintech, as also mentioned by Pytcowska and Korynsky (2017), to serve their members/customers, which mostly millennials (24– 40 years old) of smartphone and internet users, but they lack resources to adopt fintech at this time. The adoption of fintech by IMFI for SIMF, as well as for C-IMF would improve the financial inclusion, which subsequently could translate into a reduction of poverty and income gap (Yeow et al., 2018). Moreover, the adoption of fintech by IMFI could also be considered as a tool to survive and thrive in the future (Leong et al., 2017).

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The adoption of fintech in S-IMF would improve the outreach of IMFI to the donors of zakat, infaq and waqf to be used in consumptive program, productive program and other social programs for mustahiq, the poor and surrounding community, as also mentioned by Rachman and Salam (2018) and Yahaya and Ahmad (2018). The adoption of fintech in C-IMF would improve the outreach of IMFI to the investors, improve the outreach to unbanked and underbanked people, increase financial inclusion, reduce operating costs, and improve IMFI’s sustainability, as also mentioned by Leong et al. (2017) and Yeow et al. (2018). Finally, the adoption of fintech by any type of IMFI would make it possible for IMFI to reach the microfinance triple bottom-line suggested by Zeller and Meyer (2002), including outreach to the poor, sustainability of the IMFI and improve welfare of the poor.

3

Methodology

This study applies the Delphi method combined with the Likert scale to determine the characteristics of fintech needed by Islamic microfinance. Subsequently, this study uses the determined characteristics to design and proposed various micro-fintech models suitable for IMFI/BMT in Indonesia. The respondent of this study comprises of three groups, including 11 experts, 11 BMT practitioners and 8 Fintech practitioners. These three groups of respondents are needed, since their different views are importantly required to capture three different point of views on fintech for Islamic microfinance. Experts’ views are needed to provide ideal and normative perspective on the topic, BMT practitioners’ views are important to understand their standpoint in implementing fintech, while Fintech practitioners’ views are necessary to capture the practical perspective in adopting fintech for Islamic microfinance. Delphi method is a qualitative method developed by Dalkey and Helmer (1963) to acquire knowledge or opinions of the experts in certain field or topic, in this case the fintech for Islamic microfinance to be adopted by IMFI/BMT. This method comprises a series of two or more focused group discussions (FGD) for each group of respondents to come up with an agreement among the member of the group on the topic discussed. Initially, in-depth interviews with respondents are conducted to capture the fintech characteristics needed by IMFI/BMT from three

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different point of views of experts, BMT practitioners and Fintech practitioners. Secondly, these lists of characteristics are then distributed to the first round FGD members to add to the list of characteristics he/she feels need to be added. Thirdly, the new lists are distributed in the second round FGD to the members to rank and fill out the Likert scale 1–5 (1 very disagree; 2 disagree; 3 neutral; 4 agree; 5 very agree) of their assessment. If these results have shown a significant agreement, then conclude. The agreement is shown by the Kendall coefficient of concordance (W), and the significance is shown by P-value of less than 10%. If the results have not come to an agreement, the third-round FGD is needed to improve the agreement, and so on, until agreement among the members of FGD achieved.

4 New Sustainable Islamic Microfinance Model for Imfi 4.1

Characteristics of Micro-Fintech Model for IMFI/BMT

Some of the essential characteristics of micro-fintech model for BMT based on the surveys to experts, BMT practitioners and Fintech practitioners can be seen in Table 1. The micro-fintech needed by IMFI/BMT to be adopted in the commercial sector agreed by all respondents is crowdfunding peer-topeer (P2P) financing, complemented with payment and digital banking, although BMT prefers to implement digital banking first, followed by crowdfunding P2P financing, showing that BMTs feel more comfortable to collect commercial funding by itself first using digital banking to maintain their independence before turning to other sources, such as fintech. In the social sector, all respondents agree that crowdfunding P2P social should be implemented first, complemented with payment and digital banking. This is also confirmed for ZIS, waqf and integrated ZISWaf. BMTs realize that they have limitation in collecting zakat, infaq, sadaqa, and waqf (ZISWaf), where they cannot just collect ZISWaf from their members, since most members are poor people and MSEs, so that they need to reach out to the haves outside their communities. In addition, e-commerce is the next micro-fintech to be adopted afterwards. All of

Type of micro-fintech to be adopted in commercial area Digital banking Payment Crowdfunding P2P financing E-commerce Insurtech Capital market Integrated (various fintech needed) Type of micro-fintech to be adopted in social area Digital banking Payment Crowdfunding P2P social E-commerce Insurtech Capital market Integrated (various fintech needed) Micro-fintech for ZIS to be adopted Digital banking Payment P2P social E-commerce Other micro-fintech Any micro-fintech needed gradually Micro-fintech waqf to be adopted:

1

2.1 2.2 2.3 2.4 2.5 2.6 2.7 3 3.1 3.2 3.3 3.4 3.5 3.6 4

1.1 1.2 1.3 1.4 1.5 1.6 1.7 2

Characteristic

6 6 10 5 4 1 7 AG 6 10 9 4 3 6 AG

7 9 10 6 2 3 4 AG

AG

Expert

Characteristics of micro-fintech needed by BMT

No.

Table 1

3 4 1 2 4 3 2 NE 2 1 2 4 4 5 NE

3 2 1 4 6 3 4 NE

NE

2 1 0 4 3 7 2 DI 3 0 0 3 4 0 DI

1 0 0 1 3 5 3 DI

DI

10 9 11 4 4 4 6 AG 10 10 10 8 6 8 AG

11 8 9 6 3 3 9 AG

AG

BMT

1 2 0 5 5 1 3 NE 1 1 1 2 5 3 NE

0 3 2 5 8 6 2 NE

NE

0 0 0 2 2 6 2 DI 0 0 0 1 0 0 DI

0 0 0 0 0 2 0 DI

DI

5 6 8 5 4 0 6 AG 6 8 7 3 2 1 AG

5 6 8 6 3 4 4 AG

AG

Fintech

2 1 0 3 3 6 1 NE 2 0 1 5 3 4 NE

3 1 0 2 4 2 3 NE

NE

1 1 0 0 1 2 1 DI 0 0 0 0 3 3 DI

0 1 0 0 1 2 1 DI

DI

21 21 29 14 12 5 19 AG 22 28 26 15 11 15 AG

23 23 27 18 8 10 17 AG

AG

ALL

6 3 7 2 1 0 10 6 12 6 10 15 6 5 NE DI 5 3 2 0 4 0 11 4 12 7 12 3 NE DI

6 1 6 1 3 0 11 1 18 4 11 9 9 4 NE DI

NE DI

356 ASCARYA AND A. SAKTI

Digital banking Payment P2P social E-commerce Other micro-fintech Any micro-fintech needed gradually Integrated micro-fintech ZIS-Waf to be adopted Digital banking Payment P2P social E-commerce Other micro-fintech Any micro-fintech needed gradually Micro-fintech digital banking to be adopted by IMFI/BMT Built by IMFI/BMT itself Built jointly by similar type of IMFI/BMT Built jointly in APEX/Association by members Built by APEX/Association Collaborate with existing Fintech Company Micro-fintech payment to be adopted by IMFI/BMT Built by IMFI/BMT itself Built jointly by similar type of IMFI/BMT Built jointly in APEX/Association by members

4.1 4.2 4.3 4.4 4.5 4.6 5

7.1 7.2 7.3

6.1 6.2 6.3 6.4 6.5 7

5.1 5.2 5.3 5.4 5.5 5.6 6

Characteristic

No.

3 4 9

1 4 10 8 9 AG

5 8 11 3 3 7 AG

4 8 11 4 3 7 AG

Expert

0 7 2

4 6 1 3 2 NE

3 2 0 4 4 4 NE

5 1 0 4 7 3 NE

8 0 0

6 1 0 0 0 DI

3 1 0 4 4 0 DI

2 2 0 3 1 1 DI

8 8 11

6 8 10 11 6 AG

10 11 10 7 7 9 AG

10 10 10 6 5 8 AG

BMT

0 2 0

2 2 1 0 5 NE

0 0 1 4 4 2 NE

0 1 1 4 6 3 NE

3 1 0

3 1 0 0 0 DI

1 0 0 0 0 0 DI

1 0 0 1 0 0 DI

1 3 5

1 5 5 5 8 AG

5 7 7 3 3 3 AG

5 8 7 4 2 3 AG

Fintech

0 3 2

0 2 1 0 0 NE

2 1 1 5 3 3 NE

2 0 1 4 3 2 NE

7 2 1

7 1 2 3 0 DI

1 0 0 0 2 2 DI

1 0 0 0 3 3 DI

0 12 4

18 3 1

6 16 10 3 3 2 3 3 7 0 NE DI

5 5 3 1 2 0 13 4 11 6 9 2 NE DI

7 4 2 2 2 0 12 4 16 4 8 4 NE DI

(continued)

12 15 25

8 17 25 24 23 AG

20 26 28 13 13 19 AG

19 26 28 14 10 18 AG

ALL

15 PROPOSING NEW ISLAMIC MICROFINANCE MODEL …

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Built by APEX/Association Collaborate with existing Fintech Company Micro-fintech P2P financing to be adopted by IMFI/BMT Built by IMFI/BMT itself Built jointly by similar type of IMFI/BMT Built jointly in APEX/Association by members Built by APEX/Association Collaborate with existing Fintech Company Micro-Fintech P2P Social to be Adopted by IMFI/BMT Built by IMFI/BMT itself Built jointly by similar type of IMFI/BMT Built jointly in APEX/Association by members Built by APEX/Association Collaborate with existing Fintech Company Micro-fintech E-commerce to be adopted by IMFI/BMT: Built by IMFI/BMT itself Built jointly by similar type of IMFI/BMT Built jointly in APEX/Association by members Built by APEX/Association Collaborate with existing Fintech Company Private closed ecosystem appropriate for IMFI/BMT For individual IMFI/BMT

7.4 7.5 8

11.1

10.1 10.2 10.3 10.4 10.5 11

9.1 9.2 9.3 9.4 9.5 10

8.1 8.2 8.3 8.4 8.5 9

Characteristic

(continued)

No.

Table 1

8

3 3 8 9 10 AG

1 8 8 6 8 AG

1 6 9 7 7 AG

6 9 AG

Expert

1

0 6 3 2 1 NE

2 2 2 3 2 NE

2 5 2 3 3 NE

3 1 NE

2

8 2 0 0 0 DI

8 1 1 2 1 DI

8 0 0 1 1 DI

2 1 DI

7

5 9 10 11 11 AG

7 8 11 11 10 AG

8 9 9 8 8 AG

8 9 AG

BMT

0

3 1 1 0 0 NE

1 2 0 0 1 NE

0 1 2 3 2 NE

3 2 NE

4

3 1 0 0 0 DI

3 1 0 0 0 DI

3 1 0 0 1 DI

0 0 DI

4

1 2 4 7 8 AG

2 4 4 5 8 AG

1 1 6 7 8 AG

5 8 AG

Fintech

4

0 4 3 0 0 NE

0 3 3 2 0 NE

2 6 1 0 0 NE

2 0 NE

0

7 2 1 1 0 DI

6 1 1 1 0 DI

5 1 1 1 0 DI

1 0 DI

19

9 14 22 27 29 AG

10 20 23 22 26 AG

10 16 24 22 23 AG

19 26 AG

ALL

5

6

3 18 11 5 7 1 2 1 1 0 NE DI

3 17 7 3 5 2 5 3 3 1 NE DI

4 16 12 2 5 1 6 2 5 2 NE DI

8 3 3 1 NE DI

358 ASCARYA AND A. SAKTI

For APEX or Association For individual IMFI/BMT within city/regency For individual IMFI/BMT within provincial area For All IMFI/BMT Any option as needed Public closed ecosystem appropriate for IMFI/BMT For APEX or Association For individual IMFI/BMT within city/regency For individual IMFI/BMT within provincial area For All IMFI/BMT Any option as needed Limited open ecosystem appropriate for IMFI/BMT For individual IMFI/BMT For APEX or Association For individual IMFI/BMT within city/regency For individual IMFI/BMT within provincial area For All IMFI/BMT Any option as needed

11.2 11.3 11.4

13.5 13.6

13.1 13.2 13.3 13.4

12.4 12.5 13

12.1 12.2 12.3

11.5 11.6 12

Characteristic

No.

7 6

5 8 6 6

4 5 AG

9 6 8

3 7 AG

9 5 3

Expert

3 3

3 2 4 5

6 3 NE

1 5 2

4 3 NE

1 5 5

1 2

3 1 1 0

1 3 DI

1 0 1

4 1 DI

1 1 3

9 6

7 10 9 8

8 3 AG

8 5 5

5 4 AG

8 1 2

BMT

0 4

2 0 1 2

1 6 NE

1 3 3

2 5 NE

0 6 5

2 1

2 1 1 1

2 2 DI

2 3 3

4 2 DI

3 4 4

4 4

4 4 4 4

4 4 AG

4 4 5

4 4 AG

6 4 4

Fintech

3 3

2 4 4 4

3 3 NE

3 4 3

3 2 NE

2 4 4

1 1

2 0 0 0

1 1 DI

1 0 0

1 2 DI

0 0 0

20 16

16 22 19 18

16 12 AG

21 15 18

12 15 AG

23 10 9

ALL 4 5 7

4 3 4

6 10

7 6 9 11

4 4

7 2 2 1

10 4 12 6 NE DI

5 12 8

9 9 10 5 NE DI

3 15 14

15 PROPOSING NEW ISLAMIC MICROFINANCE MODEL …

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Table 2

Micro-fintech needed by IMFI/BMT

No.

Fintech type

1 2 3 4 5 6

Digital banking Payment P2P financing P2P Social E-commerce Other micro-fintech

Baitut Tamwil

Baitul Maal V V

V –

– V V Less priority

these micro-fintech types would be preferred if they are adopted as integrated micro-fintech. Therefore, the type of fintech needed by BMT to be adopted can be seen in Table 2. The implementation of P2P financing and P2P social adopts offline to online (OTO) approach, where commercial investor and social donor will be conducted online, while financing extension and ZISWaf disbursement will be conducted offline by the BMT since the value of emotional bonding between BMT and its member cannot be replaced by technology. All of those micro-fintech needed by BMT are preferred to be built jointly in APEX/Association by members, to be built by APEX/Association, or to be collaborated with existing Fintech Co., since these are the rational and logical choices to be taken at this time, due to the limitations of BMT in the capital expenditure and expertise of fintech. Meanwhile, the most preferred micro-fintech models to be adopted are private closed ecosystem for APEX/Association, limited open ecosystem for APEX/Association, and public closed ecosystem for APEX/Association, followed by limited open ecosystem for all IMFI/BMT and private closed ecosystem for individual IMFI/BMT. 4.2

Robustness

One way to check the robustness of expert opinion surveys is calculating the agreement among respondents called rater agreement measured by Kendall coefficient of concordance, denoted by W , ranged from 0 no agreement to 1 total agreement, coupled with the significance (P-value) of the rater agreement.

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Table 3 shows that all respondents have agreed significantly on 12 out of 13 questions they responded to, were these results also similar for expert responses. There was only one disagreement on the question of “limited open ecosystem model appropriate for IMFI/BMT.” Fintech practitioners also resulted in agreement significantly on 12 out of 13 questions, and disagree on only one question on “private closed ecosystem model appropriate for IMFI/BMT.” Moreover, BMT practitioners have also come to a significant agreement on 11 out of 13 questions. Overall, there is only 7.7% disagreement (1 out of 13 questions) among all respondents of expert, BMT practitioner and fintech practitioner, so that overall, there is a convergence opinion among all respondents (92.3%). 4.3

Proposed Micro-Fintech Models for IMFI/BMT

The first three preferred models are micro-fintech built-in APEX/Association, showing the urgency to adopt fintech, although the BMTs have to jointly build it in the APEX/Association. The BMTs also realize that they are small and they have to unite to be big, strong, heard, and sustainable. Moreover, the BMTs prefer to have a private closed ecosystem, where the BMTs within their APEX/Association choose to build their own micro-fintech to maintain their independence. Therefore, the first proposed micro-fintech model can be illustrated in Fig. 1. In this model, BMT is a member of its APEX or Association. Membercustomer of BMT could obtain various commercial services of BMT, such as core banking services and payments, as well as social services of BMT, such as pay zakat, infaq and waqf directly offline through BMT. Member-customer of BMT could also obtain those services online through micro-fintech at the APEX or Association. Meanwhile, external investor, muzakki, waqif and other donor could use microfintech APEX/Association to invest, pay zakat or donate waqf/infaq to certain BMT. In addition, all interactions between BMT and its membercustomer in financing to MSE, investment in the real sector, zakat program disbursement to mustahik and waqf/infaq social programs to mauquf ‘alaih are conducted via offline. The BMTs second most preferred micro-fintech model is a limited open ecosystem for APEX/Association-Fintech Co., where BMTs thru their APEX/Association collaborate with Fintech Co. (company) to

Type of micro-fintech to be adopted in commercial area Type of micro-fintech to be adopted in social area Micro-fintech for ZIS to be Adopted: Micro-fintech Waqf to be adopted Integrated micro-fintech ZIS-Waf to be adopted Micro-fintech digital banking to be adopted by IMFI Micro-fintech payment to be adopted by IMFI Micro-fintech P2P financing to be adopted by IMFI Micro-fintech P2P social to be adopted by IMFI Micro-fintech e-commerce to be adopted by IMFI Private closed ecosystem appropriate for IMFI Public closed ecosystem appropriate for IMFI Limited open ecosystem appropriate for IMFI

1

0.024

0.233

0.468

0.658

0.345

0.436

0.336

0.395

0.407 0.379 0.416

0.575

0.395

Expert

0.393 0.440 0.478 0.541 0.260 0.107 0.132 0.235 0.284 0.244 0.220

0.000*** 0.000*** 0.001*** 0.000*** 0.002*** 0.005*** 0.001*** 0.004*** 0.000*** 0.000*** 0.036**

0.235

0.489

0.000***

0.931

BMT

P-value

Rater agreement (W)

0.303 0.238

0.024**

0.134

0.591

0.253

0.516

0.478

0.378

0.725 0.618 0.552

0.584

0.448

Fintech

0.046**

0.020**

0.014**

0.035**

0.213

0.316

0.022**

0.000*** 0.000*** 0.000***

0.000***

0.000***

P-value

*** significant at the 0.01 level; ** significant at the 0.05 level; * significant at the 0.10 level

13

12

11

10

9

8

7

6

3 4 5

2

Characteristic

Rater agreement (Kendall W ) of respondents

No.

Table 3

0.091*

0.046**

0.374

0.001***

0.088*

0.002***

0.004***

0.017**

0.000*** 0.000*** 0.000***

0.000***

0.000***

P-value

0.042

0.072

0.147

0.440

0.224

0.210

0.214

0.259

0.400 0.371 0.367

0.454

0.393

ALL

0.283

0.070*

0.001***

0.000***

0.000***

0.000***

0.000***

0.000***

0.000*** 0.000*** 0.000***

0.000***

0.000***

P-value

362 ASCARYA AND A. SAKTI

15

Member1 Muzakki Waqif-Munfiq Investor Waqif-Munfiq Muzakki Member2

Fig. 1

Off/On

BMT1

Fintech APEX/Assoc.

Off/On

Offline

Offline

BMT2

Offline

363

MSE1 Mustahik1 Mauquf ‘Alaih1 Real Sector Mauquf ‘Alaih2 Mustahik2 MSE2

Private closed ecosystem model of APEX/Association

Member1 Muzakki Waqif-Munfiq Investor Waqif-Munfiq Muzakki Member2

Fig. 2

PROPOSING NEW ISLAMIC MICROFINANCE MODEL …

Off/On

Fintech COMPANY

Off/On

BMT1

APEX/ Associa on

BMT2

Offline

Offline

Offline

MSE1 Mustahik1 Mauquf ‘Alaih1 Real Sector Mauquf ‘Alaih2 Mustahik2 MSE2

Limited open ecosystem model of APEX/Association-Fintech Co.

collect commercial funding and social funding (ZISWaf) due to several reasons. First, fintech is still expensive, while BMTs do not have necessary capital to build their own fintech. Second, the BMTs have expertise in traditional Islamic microfinance with the benefit of emotional bonding with their member-customers but do not have expertise in fintech. Third, the outreach of BMTs are limited only to their surrounding communities. Therefore, collaboration with Fintech Co. is intended to break these barriers to reach out to external investors and donors (of ZISWaf). Therefore, the second proposed micro-fintech model can be illustrated in Fig. 2. In this model, micro-fintech, especially P2P financing and P2P social, will be collaborated between APEX/Association with Fintech Co. Member-customer of BMT could obtain commercial and social services directly from BMT offline. Meanwhile, member-customer of BMT as well as external investor, muzakki and waqif/munfiq could also obtain microfintech products and services through Fintech Co. or APEX/Association.

364

ASCARYA AND A. SAKTI

In addition, all interactions between BMT and its member-customer in financing to MSE, investment in the real sector, zakat programs to mustahik and waqf/infaq social programs to mauquf ‘alaih are still conducted via offline. The third most preferred micro-fintech model for BMT is public closed ecosystem for APEX/Association, where the government develops public fintech to serve BMTs through their APEX/Association, as can be seen in Fig. 3, where it is similar to Fig. 2, but replacing Fintech Co. with Public Fintech, which makes limited open ecosystem becomes public closed ecosystem, since the BMTs’ data would be kept by the public fintech or by the APEX/Association. This model includes government involvement/intervention, which is a bit unusual, since microfinance usually is less regulated with less government involvement compare to regular finance. This model provides BMTs with various online micro-fintech services, especially P2P financing and P2P social, through their APEX/Association, provided by government fintech, so that BMTs could meet its funding needs as well as raise ZISWaf from internal and external investors and donors (muzakki, waqif and munfiq) effectively. The fourth micro-fintech model for BMT is limited open ecosystem model for BMTs, where BMTs collaborate directly with Fintech Co. to meet their needs for commercial funding and social fundraising (see Fig. 4). This is the most direct model of BMT-Fintech Co. collaboration, and therefore the most applicable for the time being. Viewed from Fintech Co. in commercial side, BMT serves as data point who provide data and recommendation on the MSEs eligible to be funded by investors through Fintech Co., while viewed from BMT,

Member1 Muzakki Waqif-Munfiq Investor Waqif-Munfiq Muzakki Member2

Fig. 3

Off/On

PUBLIC Fintech

Off/On

BMT1

APEX/ AssociaƟon

BMT2

Offline

Offline

Offline

Public closed ecosystem model of APEX/Association

MSE1 Mustahik1 Mauquf ‘Alaih1 Real Sector Mauquf ‘Alaih2 Mustahik2 MSE2

15

PROPOSING NEW ISLAMIC MICROFINANCE MODEL … Off/On

Member1 Muzakki Waqif-Munfiq

Fintech COMPANY

Investor Waqif-Munfiq Muzakki Member2

Fig. 4

Offline

Offline

BMT2

Off/On

Offline

MSE1 Mustahik1 Mauquf ‘Alaih1 Real Sector Mauquf ‘Alaih2 Mustahik2 MSE2

Limited open ecosystem model of BMT-Fintech Co.

Member Muzakki Waqif-Munfiq

Off/On

Online

Government Investor Member

Fig. 5

BMT1

365

Off/On

Baitul MAAL Fintech BMT Baitut TAMWIL

Offline

Offline

Offline

Mustahik M. ‘Alaih Social Program Real Sector MSE

Private closed ecosystem model of BMT

Fintech Co. serves as agent to help BMT reach out to investors for commercial funding and to donors for social ZISWaf fundraising. The commercial fintech and the social fintech could be integrated within single Fintech Co., but it could also be separated in two different Fintech Co. The fifth micro-fintech model for BMT is private closed ecosystem model for BMT, where BMT develops its own fintech, which could be gradual according to its needs. This model still adopts offline to online approach, but BMT should have expertise in fintech to operate its own micro-fintech (see Fig. 5). This micro-fintech model provides BMT with independence in developing and operating tailor-made fintech most suitable for the BMT. This model has no similarity with the previous models, where fintech is operated by other party serving the BMT. In this model, membercustomer could access BMT’s products/services offline or online, while external investors and donors could be reached online. Zakat programs to mustahik, social waqf programs to mauquf ‘alaih and other social

366

ASCARYA AND A. SAKTI

programs, as well as financing programs and investment in the real sector would be conducted offline. 4.4

Discussions

The development of fintech in microfinance is an inevitable necessity, including in Islamic microfinance. BMT in Indonesia is an Islamic microfinance institution (IMFI) incorporated as a cooperative (Islamic financing and savings cooperative or KSPPS), where the relationship between BMT and its members is not only in Islamic microfinance transactions, but also into emotional bonding between. However, IMFI/BMT must also be adaptive to changing times, including in terms of technology, especially financial technology or fintech. In the next five to ten years the member-customer of IMFI/BMT will change in large part to the millennial generation that cannot be separated from technology (digital native), but the emotional bonding between member-customer and BMT is a social capital which provides added value and the IMFI/BMT identity as an adherent to achieve wellbeing. In the business world there is a philosophy that “If you cannot beat them join them”, so that the attitude of IMFI/BMT toward fintech should be adaptive to alter threats into opportunities by gradually adopting micro-fintech based on the priority, which could be built by individual BMTs, built by APEX/Association, built jointly by members of APEX/Association, built by the Government, as well as could collaborate with existing Fintech Co. Micro-fintech implementation by IMFI/BMT will gradually increase the effectiveness and efficiency of integrated Islamic commercial and social finance, including Baitul Maal in managing ZIS-Waf (zakat-infaqsadaqa and waqf) and Baitut Tamwil in managing Islamic microfinance (funding, financing and other financial services), so that BMTs can better achieve their social and commercial goals, such as alleviating poverty, improving spirituality, improving holistic financial inclusion (social inclusion and financial inclusion), developing MSEs and ultimately improving wellbeing. ZIS-Waf (including direct cash waqf) collected by Baitul Maal directly or through fintech can be used for various social programs. Social waqf will be used for social waqf programs mandated by waqif, zakat can be used for consumptive programs, productive programs and da’wah programs, while infaq can be used for broader social programs.

15

PROPOSING NEW ISLAMIC MICROFINANCE MODEL …

367

Indirect cash waqf collected by Baitul Maal directly or through fintech can be invested in Baitut Tamwil as a Waqf Long-Term Deposits or Waqf Equity, which will be used productively for MSE financing and/or real sector investment. Financing risk mitigation can be covered by micro takaful which can also be managed by IMFI/BMT. Funding from investors collected through fintech will be channeled to MSE financing using certain mode of financing (mudharabah muqayyadah or others) agreed upon. Various forms of deposits (savings and deposits) are also channeled to various debt-based, lease-based and/or equity-based financing. Meanwhile, when funding is not sufficient to meet financing demands, IMFI/BMT can seek additional funds through Islamic bank financing (see Fig. 6). Islamic bank financing can also be used as a precaution against member-customer withdrawals at certain times, such as in the month of Ramadan and in the new school year, as well as in times of stochastic economic turmoil. This diversification of funding sources can reduce the risks arising from funding problems, including the sustainability of the IMFI/BMT itself. In addition, the adoption of micro-fintech by IMFI/BMT on the commercial and social side will gradually be able to solve BMT structural problems which have never been resolved, such as the problems of funding, mismatch, liquidity, lack of lender of the last resort, credibility, as well as other governance problems. Before IMFI/BMT adopted fintech-micro, IMFI/BMT focused more on the commercial side of managing Islamic microfinance in funding, Social Waqf

Dakwah Program

Online

Fig. 6

Offline

BAITUT TAMWIL Offline

Real Sector

Prod. Program

BAITUL MAAL

FINTECH IC-Waqf Investor Deposit i-Bank

Cons. Program

Offline

Online

Sadaqa Zakat Infaq DC-Waqf

Financial Services

Offline

Micro Takaful

Micro Financing

The operation of BMT applying micro-fintech

Poverty AlleviaƟon Spiritual Improvement HolisƟc Fin. Inclusion MSE Development Wellbeing Improvement

368

ASCARYA AND A. SAKTI

financing and microfinance services. On the Liabilities side BMT has Wadiah Dhamanah saving deposits, Mudharabah investment deposits and Islamic bank financing. Pooling of these funds will be channeled to financing using various modes of financing, such as debt-based and equity-based financing. On the social side, IMFI/BMT conducts various social activities incidentally (collecting and distributing zakatinfaq-sadaqa), so that Islamic social finance would not appear on the balance sheet. Thus, the IMFI/BMT balance sheet can be illustrated as follows (Table 4). Moreover, the fund management system adopted by the BMT is a pooling of fund system that brings together all funding to be channeled into financing with various durations from short, medium to long term. The tenure of funding is not related to the tenure of financing. This model is similar to the system adopted by conventional banks including conventional cooperatives, so there is a cost of fund concept, financing (so the contracts start with the word “financing,” such as mudharabah financing, which is not pure mudharabah, and so on) and return on financing. These practices would result in classic (structural) problems of IMFI/BMT, such as mismatch and liquidity problem, which require liquidity management and supporting infrastructure, such as the Islamic money market between BMT and lender of the last resort (or the central bank of BMT) that will help BMT when in times of those difficulties. Without this supporting infrastructure, IMFI/BMT will always be haunted by the collapse of IMFI/BMT at any time (Fig. 7). The IMFI/BMT balance sheet and the pooling of fund system previously mentioned, with Islamic bank financing to cover funding shortages, Table 4 BMT balance sheet before applying micro-fintech

On balance sheet Assets

Liabilities

Cash Islamic bank deposits

Wadiah saving deposits Mudharabah investment deposits Islamic bank financing

Receivables (Murabahah, Ijarah, etc.) Financing (Mudharabah, Musharakah, etc.) Fixed assets

Capital

15

PROPOSING NEW ISLAMIC MICROFINANCE MODEL …

USES ST Financing MT Financing LT Financing ASSETS

Fig. 7

369

SOURCES Return on Fin.

Cost of Fund

POOLING Liability Driven

Saving Dep. Investment Dep. Islamic Bank Fin. LIABILITIES

BMT pooling of fund before applying micro-fintech

implicitly show their structural problems, including funding, mismatch and liquidity. Since IMFI/BMT does not have IMFI/BMT money market and a lender of last resort, the IMFI/BMT becomes increasingly vulnerable to these problems, thus affecting the sustainability of the IMFI/BMT itself. After IMFI/BMT adopts micro-fintech on the commercial and social sides, the business model of IMFI/BMT has changed, IMFI/BMT could obtain funding from fintech P2P Financing which could be recorded off/on balance sheet (here it is assumed that fintech is treated off balance sheet). IMFI/BMT could also obtain ZIS-Waf collections from fintech P2P Social and/or e-Commerce which could be deposited/invested in IMFI/BMT and be recorded in the form of ZIS Saving Deposits, Waqf Long-Term Investment Deposits and Waqf Equity. On the asset side, IMFI/BMT would extend these funds to MSE financing and invest in the real sector. In addition, funding from fintech P2P would be extended to MSE financing (Table 5). If MSE financing through fintech P2P Financing is treated on balance sheet, then the IMFI/BMT balance sheet would look as follows (Table 6). With the adoption of micro-fintech, the fund management system adopted by BMT not only uses the pooling of fund system but also begins to use the allocation of funds system for cash waqf and fintech P2P Financing. In this allocation of fund system, IMFI/BMT initially identifies the real sector projects of its member-customer to be financed, and then seeks the needed investment (according to the amount and tenure) to finance the project. This model could minimize the problem of mismatch and liquidity, as well as the need for liquidity management and supporting infrastructure. This model is not adopted in the conventional bank or conventional cooperative, but it is typical in Islamic finance which connects

370

ASCARYA AND A. SAKTI

Table 5 BMT balance sheet-1 after applying micro-fintech

On balance sheet Assets

Liabilities

Cash Islamic bank deposits Receivables (Murabahah, Qardh, etc.) Financing (Mudharabah, Musharakah, etc.)

Wadiah saving deposits ZIS saving deposits Mudharabah investment deposits Islamic bank financing

Real sector investments Fixed assets OFF BALANCE SHEET ASSETS Financing (Mudharabah Muqayyadah)

Table 6 BMT balance sheet-2 after applying micro-fintech

Waqf LT investment deposits Waqf equity Capital LIABILITIES Fintech investment

On balance sheet Assets

Liabilities

Cash Islamic bank deposits Receivables (Murabahah, Qardh, etc.) Financing (Mudharabah, Musharakah, etc.) Financing (Mudharabah Muqayyadah)

Wadiah saving deposits ZIS Saving Deposits Mudharabah investment deposits Islamic bank financing

Real sector investments Fixed assets

Fintech investment Waqf LT investment deposits Waqf equity Capital

directly mudarib (member-entrepreneur who need financing) with sahibul maal (investor), while IMFI/BMT acts as an agent/intermediary, using pure Muqayyadah Mudharabah contract, not mudharabah muqayyadah financing, so that it is recognized as asset, not receivables, with return on assets as profit. For investors, they will receive an investment return (or return on investment) according to the ratio agreed upon. Here

15

PROPOSING NEW ISLAMIC MICROFINANCE MODEL …

371

there is no cost of fund concept because IMFI/BMT is only an agent/intermediary who receives fees. This will shift the mindset or paradigm of IMFI/BMT from the old system of pooling of funds to the new system of allocation of funds, which must be understood by all IMFI/BMT stakeholders gradually. In the old pooling of fund system, the management of IMFI/BMT must think of a low cost of fund, feasibility financing, return/margin on financing that must cover operational costs + cost of funds + profit, collateral, asset-liability management (ALM) which contains mismatch, as well as other risks associated with the pooling of fund system which is inherently unstable. In the new system of allocation of funds, IMFI/BMT management will not be burdened with the problem of the cost of funds, mismatch, return/margin that must cover operational costs + cost of funds + profits, or other risks associated with the pooling of funds, but now they have to focus more on the characteristics, feasibility and risk level of the business (and member-entrepreneur) to be financed, finding or offering the right source of funding for the business to be financed, as well as covering the risks associated with the allocation of funds (Fig. 8). The IMFI/BMT balance sheet and the hybrid pooling-allocation of fund system discussed above show an improvement in its liabilities, both in funding and equity. Funding is strengthened in terms of quantity (increasing amount) and quality (suitable and/or long term), thereby reducing the dependency on external parties, reducing mismatch and reducing liquidity risk. Equity or capital is also strengthened with the addition of the Waqf Equity, which would increase IMFI/BMT’s ability to expand financing. USES ST Financing MT Financing LT Financing

SOURCES Return on Fin.

Cost of Fund

POOLING

Saving Dep. Investment Dep. Islamic Bank Fin.

Liability Driven

Any Financing Any Financing Real Sector

ASSETS

Fig. 8

ALLOCATION Return on Asset

ALLOCATION

Fintech Investor Investment Return

Asset Driven

BMT mixed of fund after applying micro-fintech

Waqf Investment

LIABILITIES

372

ASCARYA AND A. SAKTI

In the long run, the adoption of micro-fintech by IMFI/BMT will gradually shift its balance sheet structure. On the liabilities side, savings are offered by all Wadiah Amanah (Wadiah Saving Deposits and ZIS Saving Deposits), so that they cannot be used as part of the pooling of funds. Deposit investments offered are all Mudharabah Mutlaqah (Mudharabah Investment Deposits and Waqf Long-Term Investment Deposits) with a minimum period of one month. In addition, Mudharabah Muqayyadah investment (Mudharabah Muqayyadah Investment) is offered on/off balance sheet to finance productive MSE financing (Table 7). If MSE financing through fintech P2P Financing is treated on balance sheet, then the IMFI/BMT balance sheet would look like as follows (Table 8). In addition, the fund management system adopted by BMT further reduces the use of the pooling of fund system, and further increases the use of the allocation of fund system from cash waqf funds, fintech P2P Financing and Mudharabah Muqayyadah Financing. With the replacement of savings contracts (Wadiah Saving Deposits and ZIS Saving Deposits) from Wadiah Dhamanah to Wadiah Amanah, savings (Saving Deposits) are no longer part of the pooling fund, but it has to be held as reserve, which means that the BMT is always ready if a depositor withdraws his/her deposits. Thus, investment deposits Table 7 BMT balance sheet-1 after applying micro-fintech and Mudharabah Muqayyadah On balance sheet Assets

Liabilities

Cash Islamic bank deposits Receivables (Murabahah, Qardh, etc.) Financing (Mudharabah, Musharakah, etc.) Financing (Mudharabah Muqayyadah) Real sector investments Fixed assets OFF BALANCE SHEET ASSETS Financing (Mudharabah Muqayyadah)

Wadiah saving deposits ZIS saving deposits Mudharabah Investment Deposits Mudharabah Muqayyadah Investment Waqf LT investment deposits Waqf equity Capital LIABILITIES Fintech investment

15

PROPOSING NEW ISLAMIC MICROFINANCE MODEL …

373

Table 8 BMT balance sheet-2 after applying micro-fintech and partial Mudharabah Muqayyadah On balance sheet Assets

Liabilities

Cash Islamic bank deposits Receivables (Murabahah, Qardh, etc.) Financing (Mudharabah, Musharakah, etc.) Financing (Mudharabah Muqayyadah)

Wadiah saving deposits ZIS saving deposits Mudharabah investment deposits Mudharabah Muqayyadah investment Fintech investment Waqf LT investment deposits Waqf equity Capital

Real sector investments Fixed assets

(Mudharabah Investment Deposits) are left to be part of the pooling of funds that can be channeled to MSE financing in the medium or short term. Therefore, the portfolio of allocation of fund would be greater than the portfolio of pooling of funds. Meanwhile, IMFI/BMT also starts to provide/offer Mudharabah Muqayyadah Investment directly without going through fintech. This is suitable for dealing with mismatch and liquidity problems for small IMFI/BMT or those who cannot collaborate with Fintech Co. This business model has been implemented by several IMFIs/BMTs, such as BMT Ibadurrahman in Bogor, which have proven effective in overcoming their mismatch and liquidity problems (Fig. 9). The IMFI/BMT balance sheet and the hybrid pooling-allocation of fund system, in the long run, will be able to eliminate IMFI/BMT dependence on Islamic bank financing, FDR will decrease below 100%, mismatch will decrease drastically and there will be almost no liquidity risk. This is because the pooling of fund model is getting smaller, while the allocation of fund model is getting larger. The pooling of fund model that is still used would only use term investment deposits which have lower liquidity risk. In other words, the fractional reserve banking system model would be minimal and would be replaced by the full (100%) reserve banking system model (Table 9). In the end IMFI/BMT would not offer term investment deposit anymore, replaced by Mudharabah Muqayyadah Investment, while saving

374

ASCARYA AND A. SAKTI

USES ST Financing MT Financing

SOURCES Cost of Fund

Return on Fin.

POOLING

Saving Dep. Investment Dep.

Liability Driven

Any Financing Any Financing Any Financing Real Sector

Return on Asset

ALLOCATION ALLOCATION

Investment Return

ALLOCATION

MM Investment Fintech Investor Waqf Investment

Asset Driven

ASSETS

LIABILITIES

Fig. 9 BMT mixed of fund after applying micro-fintech and Mudharabah Muqayyadah investment

Table 9 BMT balance sheet 3 after applying micro-fintech and fully Mudharabah Muqayyadah On balance sheet Assets

Liabilities

Cash Islamic bank deposits Receivables (Murabahah, Qardh, etc.) Financing (Mudharabah, Musharakah, etc.) Financing (Mudharabah Muqayyadah) Real sector investments Fixed assets

Wadiah saving deposits ZIS saving deposits Mudharabah Muqayyadah investment Fintech investment Waqf LT investment deposits Waqf equity Capital

deposit offered is fully applying Wadiah Amanah, so that IMFI/BMT has shifted from pooling of fund to allocation of fund fully (Fig. 10). The development of micro-fintech by IMFI/BMT if built individually by each IMFI/BMT will be quite burdensome or even not feasible for small IMFI/BMT. However, if it is jointly built by IMFI/BMT association (national and/or regional), the development of micro-fintech could be feasible and would not be a burden for individual IMFI/BMT. Therefore, in the beginning, the adoption of micro-fintech by IMFI/BMT would be feasible if IMFI/BMT enter into cooperation with Fintech Co. applying limited open ecosystem. For the near future, the adoption of micro-fintech by IMFI/BMT could be started by jointly building

15

PROPOSING NEW ISLAMIC MICROFINANCE MODEL …

USES

375

SOURCES Amanah

100% Reserve

Saving Deposit

Adm. Fee

Any Financing Any Financing Any Financing Real Sector

Return on Asset

ALLOCATION ALLOCATION

Investment Return

ALLOCATION

MM Investment Fintech Investor Waqf Investment

Asset Driven

ASSETS

LIABILITIES

Fig. 10 BMT allocation of fund after applying micro-fintech, Mudharabah Muqayyadah investment and Wadiah Amanah

micro-fintech in stages within a strong association of IMFI/BMT to improve independence. In the long run, all types of micro-fintech would be available at the IMFI/BMT association, while increasingly affordable micro-fintech would even be feasibly built by individual IMFI/BMT in stages. Therefore, the proliferation of micro-fintech development must be utilized by IMFI/BMT as an opportunity to adapt gradually to technological advancement without sacrificing its identity, by relying more on its own strength jointly in the solid association of IMFI/BMT nationally and/or regionally.

5

Concluding Remarks

Islamic microfinance institution (IMFI) or Baitul Maal wat Tamwil (BMT) must adopt fintech to survive and sustain. There are many options of micro-fintech models to be adopted by BMT, but the feasibility and best model to be adopted would be subject to several constraints, while Fintech companies also have several constraints to adopt the preferred model. On one side, BMTs would like to adopt a model which ensures their independence, while on the other side, Fintech Co. would like to enter the Islamic microfinance market. For IMFI/BMT associated with APEX or association, such as Puskopsyah and PBMT, the best micro-fintech model to be adopted is “Private Closed Ecosystem of Apex/Association,” where fintech is developed in APEX/Association jointly by all member-BMT. Meanwhile, for those

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BMTs not associated with APEX or association, they have three feasible choices to adopt micro-fintech. First, the IMFI/BMT could join the APEX or association to have access to micro-fintech APEX/Association, by complying with the requirements to join the APEX or association. Second, IMFI/BMT could collaborate with Fintech Co. and adopt “Limited Open Ecosystem of BMT-Fintech Co.” model. Third, when fintech becomes affordable and/or IMFI/BMT becomes large enough with hundreds of branches, the BMT could build the tailor-made micro-fintech for itself and adopt “Private Closed Ecosystem of IMFI/BMT” model. Therefore, in the near future, there will be three types of micro-fintech model based on three different ecosystems. First, private closed ecosystem developed by BMT or APEX/Association tailor-made to suit the need of BMTs and their members. Second, limited open ecosystem developed by Fintech Co., where BMTs could collaborate with Fintech companies to meet the BMT’s needs, especially P2P financing and P2P social. Third, the open ecosystem developed by Fintech Co. to serve the need of lowincome people and MSEs in general who do not associate with BMTs. Moreover, to solve classic problems of liquidity and mismatch and ensure the sustainability of IMFI/BMT, the business model of IMFI/BMT must adopt allocation of fund approach, including: (1) saving account must adopt Wadiah Amanah contract; (2) investment account, if still any, must adopt Mudharabah Muqayyadah contract; (3) collect cash waqf intensively to be placed as waqf long-term investment deposits or waqf equity; (4) adopt P2P financing intensively as source of commercial funding; and (5) adopt P2P social intensively to raise ZISWaf. This chapter has several implications. In developing countries, poverty is also linked to inappropriate technological infrastructure and there are countries like Korea and China, who got out of poverty by using the updated technological system. The sustainability of the microfinance industry is subject to its financial performance along with its role in alleviating poverty and socio-economic inequalities. The proposed Islamic microfinance models based on fintech will not increase financial inclusion, which will eventually reduce the poverty and income inequalities, but also enhance the transparency and efficiency of Islamic microfinance institutions. Further, the regulators and policymakers can use the proposed models and eventually designed the reforms for the sustainability of Islamic microfinance institutions.

15

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Index

A Addis Ababa, 158 adult entertainment, 204, 208 Africa, 57, 118, 133, 142, 164, 169, 173, 180, 222, 223 alcohol, 56, 66, 116, 204, 206, 208, 226 Amanah, 25, 118, 145, 169, 294, 350, 372, 374–376 animals, 225, 227–230 Asia, 57, 121, 132, 133, 142, 154, 164, 169, 173, 176, 222, 223 asset-backed, 279

B Bai’ Bithaman Ajil, 16 bai’ ‘inah, 16 Bank Muamalat, 26, 27 bankruptcy, 16, 43, 178 banks, 16, 23–26, 44, 114, 128–130, 134, 136, 142–144, 156, 158, 165, 168, 172, 176, 177, 179, 183, 184, 231, 236, 238,

241, 258, 277, 311, 312, 318, 332–337, 341–343, 351, 368 Baroque & Rose, 39 Biozer, 39

C Carbon Disclosure Project (CDP), 194 circular economy, 19, 28, 31, 48, 220, 222, 233, 234 clean energy, 114, 120, 153, 158, 181, 220, 248 Climate Sustainability, 160 commercial matters, 11, 12, 15 compact city theory, 250 compliance, 15, 16, 20–22, 30, 31, 45–47, 51, 115, 116, 124, 235, 311, 316, 351, 352 comprehensive human development (CHD), 231, 233, 234 contract(s), 12, 15, 16, 26, 28, 123, 129, 130, 136–138, 165, 175–178, 181, 278, 297, 308,

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 M. K. Hassan et al. (eds.), Islamic Finance and Sustainable Development, https://doi.org/10.1007/978-3-030-76016-8

379

380

INDEX

310, 333, 341, 352, 368, 370, 372, 376 Controversial Weapons, 204 cooperate governance, 30 Cosmecca, 39 COVID-19, 298 crisis, 22, 37, 44, 135, 154, 171, 181, 182, 267, 290, 297, 311, 331, 332 crowdfunding, 169, 355

D Darurat, 14 debt based, 31, 48 digitalization, 36, 46–48, 50, 51, 139, 277, 281, 282 dimensions, 14, 17, 28, 37, 108, 123, 152, 160, 165, 166, 182, 225, 272, 288, 291, 297 Dinar, 24, 36, 37, 42, 49, 50 Dirili¸s, 38 distribution of wealth, 159

E e-business, 49 ecological, 157, 182, 219, 221–223, 233, 234, 237, 238, 240, 242, 247, 250, 254, 258, 288 e-commerce, 39, 49, 355 economic system, 17, 115, 124, 135, 147, 179, 233, 268, 288, 317 ecosystems, 159, 160, 271, 376 education, 24, 30, 108, 111, 113, 114, 119, 151, 153, 158, 167, 271, 273, 276, 287, 288, 297, 299, 309, 318, 353 efficiency, 25, 30, 49, 113, 129, 135, 136, 141, 153, 164, 173, 182, 220, 250, 259, 274, 290, 350, 366, 376

employment, 138, 152, 173, 271, 273, 312, 317, 318, 333 empowerment, 25, 72, 111, 113, 173, 273, 277, 280, 349, 352 energy consumption, 26, 239 entrepreneurship, 19, 111, 277 environment, 13, 15–17, 19, 20, 23–26, 30, 31, 47, 61, 107, 110, 111, 113, 116, 117, 121, 123, 130, 157, 158, 165, 220–226, 232, 233, 235, 236, 239, 240, 250, 258, 266, 272, 273, 280, 282, 286, 287, 289–291, 299, 307, 352 environmental, 17, 19–21, 26, 71, 108, 111, 112, 114, 116, 117, 120, 138, 139, 156, 160, 162, 166, 182, 219–226, 229, 231–237, 239, 240, 242, 247, 250, 252, 258, 259, 266, 267, 274, 275, 279, 280, 287–289, 291, 294–297, 299 Environmental, Social and Governance (ESG), 5, 20–23, 26, 71, 78, 112, 116, 117, 123, 139, 166, 177 equal distribution, 16, 147 Ertu˘grul, 38 Ethical Finance, 26, 117 ethics, 22, 24, 28, 31, 109, 116, 222–224, 235, 258 Europe, 57, 167, 173, 223 European Sustainable Investment Forum, 194 Eurosif, 194 F falah, 17, 268 financial institutions, 13, 22, 43, 44, 46, 128, 138, 165, 166, 176, 183, 231, 236, 277, 293, 308, 310, 318, 350

INDEX

financial risk, 20, 163, 351 financial sector, 113, 114, 138, 140, 142, 169, 220, 222, 238, 239, 241, 256, 258, 278, 281 financial stability, 25, 123, 131, 267, 332, 334, 335, 337, 339, 342–344 Financial Sustainability, 160 financial system, 12, 21, 22, 30, 55, 56, 58, 61, 63, 65, 66, 68–70, 112, 113, 117, 127, 130, 134, 141, 154, 234, 236, 267, 278–282, 292, 301, 331–335, 342, 352 fintech, 42, 49, 138, 277, 353–355, 360, 361, 363–367, 369, 372–376 Fiqh Al-Mu’¯amalat, 197 Forum for Sustainable and Responsible Investment (USSIF), 194

G gambling, 15, 21, 56, 66, 77, 87, 116, 130, 194, 199, 200, 202, 204, 205, 208, 226 Genetically Modified Organism, 205 gharar, 15, 21, 130 Gharer, 77 Global Alliance for Banking on Values (GABV), 194 Global Islamic Economy Indicator (GIEI), 36 Global Reporting Initiative (GRI), 194, 196 Global Sustainable Investment Alliance (GSIA), 194 Goal 10, 273 Golden Globes, 39 Governance, 26, 27, 116, 117, 139, 319–326 government-linked companies, 165

381

green sukuk, 22, 58, 74, 121, 177, 267, 294 gross domestic product (GDP), 44, 69, 133, 134, 142, 143, 152, 163, 164, 182, 237–242, 247, 249, 251–257, 298, 313, 318–323, 325, 326

H Hajiyyat, 14 halal, 22, 31, 36, 39, 41, 49, 50, 270, 282 hawalat al-dayn, 19 health, 37, 39, 43, 108, 113, 114, 119, 122, 151–153, 158, 159, 161, 225, 226, 272, 274, 277, 287, 288, 298, 299 human development, 17, 231

I inclusion, 69, 275 Indonesia, 36, 39, 41, 42, 49, 121, 132, 139, 171, 172, 175, 180, 266, 267, 277, 299, 327, 350, 351, 353, 354, 366 Industry 4.0, 46 inequality, 19, 129, 138–141, 143, 147, 153, 271, 273, 288, 291, 299, 376 infrastructure, 49, 108, 113, 114, 119, 121–123, 151–156, 158–167, 169–185, 233, 271, 279, 282, 295, 300, 368, 369, 376 institutionalization, 11 Institutional Sustainability, 161 instruments, 19, 46, 112, 113, 116, 117, 123, 128, 231, 256, 258, 266, 270, 276, 278, 279, 282, 308, 316, 335, 349, 350, 352 insurance, 24, 165, 169, 185, 279

382

INDEX

interest-based, 233, 309, 311, 312, 317 interest-free, 16, 118, 292, 308, 309, 311, 312, 317 intermediation, 30, 45, 48, 116, 117, 123, 127, 128, 147, 301 International Federation of Red Cross and Red Crescent Societies (IFRC), 23, 122 International Integrated Reporting Council (IIRC), 196, 197 Internet of Things, 49 investment(s), 17, 20–23, 108, 112, 114–116, 120, 121, 123, 139, 152–155, 157–159, 162–169, 171–173, 176, 177, 180–184, 220, 234, 239, 250, 279, 280, 282, 289, 294, 295, 301, 313, 318, 332, 341, 349, 353, 361, 364, 366–370, 372, 373, 376 Islam, 11, 14, 21, 25, 109, 110, 146, 179, 221–226, 228, 230, 231, 233, 235, 266, 268–270, 272–274, 278, 291, 350 Islami Bank Bangladesh Limited, 23 Islamic banking, 12, 16, 23, 25, 31, 42, 114, 115, 117, 129, 131, 132, 169, 170, 176, 278, 280, 282, 311, 332–335, 337–339, 343 Islamic banks, 6, 16, 24, 25, 57, 71, 79, 81, 85, 96, 97, 114, 130, 134, 142, 143, 176, 177, 183, 311, 332, 335–337, 341–343, 351 Islamic capital market, 5, 58, 85, 86, 93, 138, 169, 184, 279–281 Islamic Development Bank, 23, 122, 129, 141, 169, 172, 231 Islamic economic(s), 19, 35–37, 45–51, 115, 124, 136, 147, 179,

231, 268, 269, 272, 275, 293, 309 Islamic-effect, 94 Islamic finance, 11–13, 15–22, 24, 25, 28–31, 35–37, 42, 44, 108, 112– 115, 117, 118, 120, 121, 123, 130–134, 137–139, 144, 147, 154, 167, 169, 170, 172–174, 176, 178, 182–184, 220, 222, 231, 259, 266–268, 270, 274, 275, 277–280, 282, 291–294, 297, 301, 308, 309, 311–313, 315, 317, 318, 321–323, 325, 369 Islamic financial industry, 12, 311, 312 Islamic financial institutions, 15–17, 21, 22, 28, 30, 130, 138, 142, 266, 267, 277, 291, 293, 308, 318 Islamic financial system, 30, 154, 183, 275, 278, 281, 297, 311 Islamic institutions, 30, 233 Islamic law, 11, 14, 45, 51, 135, 227, 231, 281 Islamic microfinance, 118, 277, 280, 282, 349–354, 363, 366, 367, 375, 376 Islamic Microfinance Institutions (IMFIs), 266, 350, 351, 353, 373 Islamic Moral Economy, 268–270, 272–274, 277, 280 Islamic mutual funds, 81, 83, 86, 94, 95 Islamic project finance, 88, 175 Islamic social, 28, 45, 49, 123, 266, 275, 276, 349, 350, 368

INDEX

J jurisdiction(s), 12, 13, 25, 30, 31, 131, 132, 163, 164, 170–174, 179

K Khalifah, 266, 269 khamr, 21 Korea, 39, 376

L land, 228 leverage, 22, 123, 156, 295, 313, 318 lockdown, 37, 38

M mafsadah, 14, 16 Malaysia, 22, 23, 25–27, 31, 36, 38, 41, 48, 49, 114, 116–119, 121, 122, 131, 132, 139, 145, 146, 170–172, 179, 184, 294, 299, 311, 327, 350 maqasid, 13–19, 21, 23, 28–31, 45, 47, 51, 109, 117, 123, 124, 135, 136, 147, 269, 270, 272, 273, 293 maqasid al-Shariah, 13, 15–18, 23, 28, 30, 31, 45, 48, 109, 117, 123, 124 maslahah, 14, 16, 48, 111 maysir, 15, 21, 130 methodology, 237, 240 microtakaful, 169 Middle East, 57, 132, 133, 169, 173, 222, 309 Middle East Sustainable Investment Forum (MESIF), 194 Millennium Development Goals (MDGs), 157, 220, 232–234, 299

383

monetary system, 30, 31 Muamalat, 11, 15, 25–27, 30, 114, 115, 119, 146 Mudharabah, 266, 368, 370, 372–376 Muqayyadah, 370, 372–376 Musharkah, 341 Muslim countries, 12, 113, 115, 118, 224, 235, 236, 275, 309, 317 Muslims, 11, 16, 35, 40, 41, 49, 139, 170, 223, 224, 227, 230, 258, 270 mutual funds, 165, 169 muzakki, 276, 361, 363, 364 N natural resources, 230 Nivea, 39 nuclear power, 205, 208 Nuclear Weapons, 204 Nurflix, 38 O objective(s), 14, 21, 24, 26, 45, 46, 49, 109, 110, 112, 118–121, 123, 135, 138, 140, 160, 161, 164, 219, 231, 233, 234, 269, 271, 273, 276, 279, 318 OECD, 36, 158, 162, 165, 166, 171, 295, 296 Organisation of Islamic Cooperation (OIC), 23, 50, 71, 122, 132, 154, 170, 171, 176–178, 182–184, 221–223, 235, 237, 240–243, 246, 250–259, 265, 267, 275, 281, 282 ownership, 20, 22, 137, 166, 176, 180, 300 P pandemic, 36–46, 48, 51, 181, 184, 298

384

INDEX

paradigm, 19, 22, 112, 220, 233, 234, 269, 290, 291, 297, 311, 371 Paris Agreement, 120, 159, 296 plants, 228 poverty, 16, 44, 108, 111, 112, 118, 119, 153, 232, 266, 271, 272, 275–277, 287, 291, 295, 298, 299, 309, 313–318, 349, 352, 353, 366, 376 products, 12, 15, 16, 19, 22, 24, 28–31, 36–39, 43, 45, 49, 50, 108, 113, 115, 118, 120, 123, 130, 136, 138, 140, 144, 155, 169, 174, 226, 238, 293, 294, 308, 312, 318, 341, 363, 365 prosperity, 22, 157, 268, 269, 288, 291, 292 P2P, 355, 360, 362–364, 369, 372, 376 public-private partnership (PPP), 158, 166, 171, 178, 182, 185

Q qard, 24, 31, 46, 310, 316–318, 352 Qard Hasan, 24, 31, 308–310, 312–318, 327 Quran, 18, 223, 225–230, 235, 308, 311

R race to bottom, 240, 250 rahn, 16, 50 regulatory framework, 42, 166, 282 REIT, 80 research and development (R&D), 220, 236, 240 riba, 15, 21, 45, 48, 130, 234, 310 risk-sharing, 112, 297

S sadaqa, 179, 180, 272, 276, 349, 353, 355, 366, 368 Salam, 14, 354 Saudi Arabia, 22, 36, 38, 41, 49, 131–133, 170, 172, 327 Second World War, 44 sentiment, 95, 97 Shariah, 12–19, 21–24, 26–31, 35, 45, 47, 48, 51, 108–114, 116, 117, 121, 123, 136, 154, 170–178, 182–185, 266, 293, 297, 308–323, 325, 327, 352 Shariah Advisory, 28, 30 Shariah Supervisory Boards, 28, 30 small and medium enterprises (SMEs), 41, 74, 174, 278 social, 13, 15, 16, 19–24, 26, 28–31, 36, 37, 40, 44–49, 51, 59, 61, 71, 112–117, 120, 123, 129, 138, 139, 147, 152, 153, 155–163, 166–170, 173, 177, 179–183, 185, 219, 221, 224, 235, 236, 266, 268, 269, 272, 274–278, 280, 281, 286–289, 291–293, 295–297, 299, 308, 349–352, 354, 355, 360–369, 376 Socially Responsible Investment (SRI), 20, 22, 26, 81, 82, 84, 99, 114, 116, 117, 119, 121, 123, 139, 166, 177 social protection, 297 social sustainability, 161 society, 13, 15–17, 19, 24, 26, 29–31, 36, 37, 44, 45, 47, 108, 111, 112, 120, 123, 134, 136, 140, 147, 151, 152, 156, 159, 179, 180, 185, 226, 233, 269, 273, 278, 279, 282, 287, 292, 295–299, 301, 311

INDEX

socio-economic, 17, 45, 108, 110, 113, 114, 116, 120, 123, 298, 376 spillovers, 155, 160, 161 spiritual, 17, 225, 270 stability, 30, 113, 181, 298, 331–335, 337–339, 342, 343 stakeholders, 15–17, 24–26, 31, 45, 46, 51, 67, 116, 136, 165, 169, 181, 289, 293, 299, 317, 351, 371 State Investment Banks, 279, 280 state owned enterprises, 165 stock returns, 80, 82, 94 Sukuk, 23, 72, 84, 91, 93, 96, 98, 114, 119, 120, 122, 123, 137, 142, 169, 171–174, 177, 279, 280, 294, 312 sustainability, 19, 24, 26, 30, 50, 110, 115–117, 139, 154, 156, 157, 159–162, 166, 173, 178, 182, 185, 222, 225, 231, 258, 267–269, 271, 272, 274, 277, 280, 282, 287, 289, 295, 299, 308, 313, 350, 351, 354, 367, 369, 376 Sustainability Accounting Standard Board (SASB), 194, 196 Sustainable Development, 116, 156, 281, 291 Sustainable Development Goals (SDGs), 1–6, 13, 17, 18, 28, 31, 59–63, 65–68, 72, 73, 78, 107–110, 112–121, 123, 153, 154, 156–158, 173, 182, 220, 233, 234, 265–268, 270–276, 278–282, 287, 292–300, 319 sustainable economy, 19, 36, 267, 275, 287, 289, 290, 318

385

sustainable infrastructure, 154, 159–161, 163–166, 170, 174, 182, 184

T Tabung Mawaddah, 26, 27 tahsiniyyat, 14, 48, 270 tawarruq, 16, 19, 31, 137 Tawhid, 269 time value of money, 79 tobacco, 21, 66, 116, 204, 206 Tokyo Olympics, 41 tourism, 41, 179, 286 transportation, 14, 115, 152, 153, 164, 173, 229, 239, 267 Triodos Bank, 23

U Umrah, 41 United Arab Emirates (UAE), 36, 42, 131, 132, 169, 170, 172, 294 United Nations, 13, 17, 24, 37, 44, 48, 107, 121, 153, 157, 160, 171, 265, 271, 272, 274, 291, 292, 307, 313

V value based intermediation (VBI), 25, 26, 28, 31, 116, 117, 123 Vezeeta, 39

W Wadiah, 368, 372–376 waqf, 26, 28, 46, 112, 113, 118, 119, 123, 167–170, 179, 180, 185, 272, 276, 278, 292, 312, 349,

386

INDEX

351–355, 361, 364–367, 369, 372, 376

wasa’il, 28

Z zakat, 26, 28, 46, 50, 66, 112, 113, 118, 123, 179, 180, 185, 233, 272, 276, 278, 292, 312, 349, 352–355, 361, 364, 366, 368 Zilzar, 49