ammended oct - dec 2016 - journal of islamic...

Journal of Islamic Banking and Finance Oct – Dec 2016 1

2 Journal of Islamic Banking and Finance Oct – Dec 2016


In The Name of Allah,

The most Beneficent, The most Merciful

“O Believers: devour not Riba, doubled and redoubled;

and fear Allah, in the hope that you may get prosperity.”

Sura Ale-Imran (verse No. 130)

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The articles published in this Journal contain references from the

sacred verses of Holy Qur’an and Traditions of the prophet (p.b.u.h) printed for the understanding and the benefit of our

readers. Please maintain their due sanctity and ensure that the pages on which these are printed should be disposed of in the

proper Islamic manner


Journal of Islamic Banking and Finance

Volume 33 Oct - Dec. 2016 No. 4 Founding Chairman Muazzam Ali (Late) Former –Vice Chairman Dar Al-Maal Al-Islami Trust, Geneva, Switzerland

Chairman Basheer Ahmed Chowdry Shariah Advisor Uzair Ashraf Usmani

Board of Editorial Advisors

Ahmed Ali Siddiqui Mufti Bilal Qazi S. A. Q. Haqqani Dr. Hasan uz Zaman Dr. Mohammad Uzair Altaf Noor Ali (ACA) Editor Aftab Ahmad Siddiqi

Associate Editor Seemin Shafi Salman Ahmed Shaikh

Manager Publication Mohammad Farhan

Published by: International Association of Islamic Banks Karachi, Pakistan. Ph: +92 (021) 35837315 Fax: +92 (021) 35837315 Email: ia _ ib @ yahoo.com

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International Academic Advisory Panel Dr. Mohammad Kabir Hassan Professor of Economics & Finance University of New Orleans, USA.

Dr. Zubair Hasan, Professor Emeritus INCEIF Global University of Islamic Finance, Malaysia. Dr. Rodney Wilson Emeritus Professor, INCEIF, Lorong Universiti A Malaysia/France. Dr. S. Nazim Ali, Professor and Director, Center for Islamic Economics and Finance, Hamad Bin Khalifa University, Doha, Qatar. Professor Dr. Mohd. Ma’sum Billah IEI, King Abdul Aziz University, Kingdom of Saudi Arabia.

Dr. Mehboob ul Hassan Professor, Department of Economics, (CBA) King Saud University, Saudi Arabia. Dr, R. Ibrahim Adebayo Department of Religions, University of Ilorin, Nigeria.

Dr. Huud Shittu Department of Religion and Philosophy, Faculty of Art University of Jos – Plateau State, Nigeria.

National Academic Advisory Panel Dr. Waheed Akhtar Assistant Professor, Comsats Institute of Information Technology (CIIT), Lahore, Pakistan. Dr. Manzoor Ahmed Al-Azhari, Associate Professor (Islamic Law) Ph.D, Legal Policy, Fac. Shariah & Law. Alazhar University, Egypt. Post Doc. Fac. of Law, Univ.of Oxford, UK.

Dr. Muhammad Zubair Usmani Jamia Daraluloom Karachi. Muhammad Zeeshan Farrukh (MBA CPIF) Islamic Banking Group of National Bank of Pakistan Team Leader-Training & Development Unit, Karachi.


Journal of Islamic Banking and Finance

Volume 33 Oct - Dec. 2016 No. 4

C O N T E N T S 1. Editor’s Note .......................................................................................................... 7 2. Shari’ah Mechanisms of Audit ............................................................................ 11

By Yousef A Basodan & Prof. Dr. Mohd Ma'Sum Billah 3. The Significance of Faith-based Ethical Principles in

Responding to the Recurring Financial Crises .................................................. 26 By S Nazim Ali, Ph.D. and Shariq Nisar, Ph.D.

4. The Impact of Sukuk investment in Developing UAE Economy ..................... 38

By Dr. Abdussalam Ismail Onagun 5. Objectivising the Social Justice Paradigm in Islamic Finance: ....................... 55

[An Appraisal] By Abdul Azeez Maruf Olayemi, Siti Mashitoh Mahamood

Marifatul Haq Yasini, Ahmad Hidayah Buang 6. Crowdfunding and the Opportunity Presented in

the American Islamic Financial Sphere.............................................................. 61 By Husam Suleiman

7. Macro-prudential Supervision in the Indonesia Financial

Services Authority (OJK) and the Role of Sharia Board: A Proposed Framework ....................................................................................... 72 By Muhammad Iman

8. Effect of Quality of Services, Bank Image, Religious Perspective on Bank Customer Loyalty (A mediator role of

customer satisfaction)........................................................................................... 86 By Amin Ur Rahman

9. Country Model: Iraq .......................................................................................... 106

10. Book Review: Adam Smith’s The Wealth of Nations: ...................................... 107 A Modern-day Interpretation

11. Islamic Capital Market Indicators ................................................................... 109


Editor’s Note Ever since 2002, Islamic banking has seen impressive and consistent growth in

Pakistan. Now, Islamic banking in Pakistan is an established industry with 12% market share achieved in just over a decade. By year-end 2015, total Islamic banking assets in Pakistan stood at Rs 1.3 trillion while total Islamic banking deposits stood at Rs 1.1 trillion.

In a recently held global conference in Karachi organized by Institution of Business Administration (IBA) Karachi, a roadmap for the future of the industry took the centre of discussions and sessions. This was a mega event in the country and global academic laureates and corporate executives of some of the distinguished institutions from around the world participated in the event from East Asia, GCC, Europe and America. The speech by respected Shaikh Mufti Taqi Usmani was a relevant reality check for the industry from the perspective of regulators. The respected scholar highlighted that Pakistan as the only country which is created on the ideology of Islam and to realize the true practical virtues of Islamic institutions in all fields of the society should have done much better than the current state of affairs.

The country’s banking industry is still being dominated by conventional banks which are explicitly involved in Riba, which is prohibited in Islam. It is unlike the situation in GCC and Malaysia where the Islamic banking industry has more than 25% share. Thus, Islamic banking regulators and patrons in the country must bear in mind that Islamic banking in Pakistan should lift from a small niche for faith-conscious target market to become a key player in the banking industry. Only by doing this, the country could hold onto the promise of being an ideological beacon for the Muslim world. According to respected Shaikh Mufti Taqi Usmani, this requires concrete and objective targets with clear time frames so that a direction is set and the performance could be reevaluated in different phases.

As a nascent industry, Islamic banking would require incentives and equal tax treatment. Islamic banks are required to undertake additional steps, procedures and unique ownership risks in order to offer Shari’ah compliant products. It is important that double taxation on asset ownership transfers and disposals is avoided. Furthermore, the government should provide strong incentives for the expansion of Sukuk market. This step could increase the investment class securities for effective liquidity management of Islamic banks.

Appreciably, with innovative product structures like running Musharakah, the Islamic banking industry has improved its finance to deposit ratio impressively. The


recent step to introduce a 2 percent tax rebate for Shariah-compliant manufacturing firms to encourage them to eliminate interest-bearing debt from their capital structure is a welcome step. The central bank has also exempted Islamic banks from using interest-based benchmarks for some equity based financing products. The central bank has also helped by lowering Islamic banks' statutory liquidity requirement to 14 percent of total demand liabilities from 19 percent, reducing the amount of liquid assets which banks must maintain as reserves. For conventional banks, the required ratio is 15 percent.

Going forward, there is a need to focus on resolving energy crisis which can improve competitiveness of the manufacturing sector. The recent decline in international oil prices and cut in policy rate by the central bank due to significant decline in inflation bodes well for Islamic banking financing operations in the future.

This issue of Journal of Islamic Banking & Finance documents scholarly contributions from authors around the globe. Contributions in this current issue discuss the theoretical underpinnings of an Islamic economy, contemporary issues in Islamic finance and performance based empirical studies on Islamic banking and finance. Below, we introduce the research contributions with their key findings that are selected for inclusion in this issue.

In their paper “ Shariah Mechanisms of Audit – Saudi Arabia and Malaysian Experiences”, Assistant Professor Yousef A. Basodan and Professor Mohd. Ma’Sum Billah, both associated with King Abdul Aziz Univeristy, Kingdom of Saudi Arabia, put forth at the role that audit plays in establishing the legitimacy of any business and discuss at length the ethical standards and values that an external auditor of an Islamic Bank must display. While these standards and traits should be present in all auditors, they become more important in context of a religion based business such as an Islamic Bank.

The two Phds., Dr. Nizam Ali, Research Professor at Centre for Islamic Economics and Finance, Hamad bin Khalifa University, Doha, Qatar and Shariq Nisar, Professor at Rizvi Institute of Management Studies and Research, Mumbai, India have co-authored a well articulated argument in their paper “The Significance of Faith-based Ethical Principles in Responding to the Recurring Financial Crises”. They present that financial crises have resulted from lack of access to financial information by customers and the regulatory gap which lets greed guide the institutions to make money at the expense of its customers and investors. They put forth their argument in the light of common ethical standards set by major world religions and how these should be built into the financial systems ethics.

In the article “The Impact of Sukuk investment in Developing UAE Economy” Dr. Abdussalam Ismail Onagun, Assistant Professor in the University of Modern Sciences, College of Business, discusses in detail the utility of Sukuk as an alternate to the conventional bond and a Shariah approved tradable instrument. He explains the different structures that Sukuk can take and the reasons that these are acceptable under the Islamic Shariah. He further presents the importance and acceptability of Sukuk in the UAE and other Islamic countries as well as its increasing popularity in western financial markets.

“Objectivising the Social Justice Paradigm in Islamic Finance” co-authored by Abdul Azeez Maruf Olayemi, Siti Mashitoh Mahamood, Marifatul Haq Yasini, Ahmad


Hidayah Buang, scholars and faculty at Malaysian universities examine the extent to which the acclaimed social justice objective is innate to the services of the Islamic financial institutions. The focal areas they discuss include the provision of benevolent loan, corporate social responsibility, the duty of the payment of Zakat, extermination of debt based instruments, total elimination of interest, gambling and uncertainty from the financial system. However, is it concluded that, although, Islamic finance strives to realize its social justice objective, nevertheless, the institution needs to raise the bar of its acclaimed financial egalitarianism further higher.

The paper “Crowdfunding and the Opportunity Presented in the American Islamic Financial Sphere” by Husam Suleiman explores the next paradigm of evolution regarding Islamic finance products in light of the development and vast success of crowdfunding platforms. The paper examines the shifting paradigm of the Islamic finance lending product in America; the Islamic finance mortgage product. Each subsequent shift in lending procedure has removed Islamic attributes associated therein; resulting with current products that have lost the substance of Islamic teachings and have fundamentally converged to the conventional product in function and form. The paper reviews the methodology and practice of crowdfunding in the current financial landscape. It discusses the advantages and attributes of crowdfunding and Islamic finance, highlighting the overwhelming similarities. The article concludes by calling upon Islamic financial product developers to explore and pursue the current opportunity presented by the natural pairing of crowdfunding and Islamic finance products.

The paper “Macro-prudential Supervision in the Indonesia Financial Services Authority (OJK) and the Role of Shari’ah Board: A Proposed Framework” by Muhammad Iman Sastra Mihajat recommends a more macro prudential framework to address systemic risks and Shari’ah risks. The paper proposes a new macro prudential framework by involving a new Shari’ah Board Authority (DPSN) under the Commissioners of OJK to regulate and supervise the Shari’ah matters for Islamic financial institutions in Indonesia. The paper discusses the challenges in adopting this new framework. The paper concludes that the current shortcomings of the macro prudential approach for Shari’ah supervision and regulation require a new Shari’ah Board Authority under the commissioners of OJK who has full authority over Shari’ah matters.

Amin-ur Rahman, an MS scholar at the International Islamic University, Islamabad, in his paper “Effect of Quality of Service, Bank Image, Religious Perspective on Bank Customer Loyalty” discussed his study on how these variables effect create customer satisfaction which in turn leads to loyalty on part of customer towards the product or service offered. He relates these aspects to banking business and how Islamic Banks can induce customer loyalty through offering good service in order to differentiate their service offering in a more or less homogenous product market.


Readers Comments

Dr. Zubair Hasan, Professor Emeritus INCEIF, Global University of Islamic Finance, Malaysia.

“The Book Review ‘The Great Escape: Health, Wealth, and the Origins of Inequality’ was brief but relevant. There is a continuing improvement in get up of the journal and the quality of the published material. Congratulations to your team.”

Disclaimer

The authors themselves are responsible for the views and opinions

expressed by them in their articles published in this Journal.

The opinions, suggestions from our worthy readers are welcome, may be communicated on

E-mail: [email protected],

Facebook: http://www.facebook.com/JIBFK, Website: www.islamicbanking.asia


Shari’ah Mechanisms of Audit Saudi Arabian and Malaysian Experiences

By

Yousef A Basodan* Mohd Ma'Sum Billah**

Abstract

It is the common regulatory culture that, an annual audit is mandatory for every company, regardless of size, that is registered under the Saudi and Malaysian Companies Act1. For this reason, the term ‘auditing’ is most commonly associated with the statutory audit of a company’s accounts or financial statements as provided under the Acts. The Acts also stipulate that an external independent auditor referred to in the Act as ‘approved company auditor’ must perform a company’s annual audit. An audit of financial statements increases the reliability of financial information for users (e.g.: managers, investors, creditors and regulatory agencies). An auditor plays an important role in this process by providing objective and independent reports on the reliability of information2. By adding the audit function in the business environment, the users of the financial statements have reasonable assurance that the financial statements do not contain material misstatements or omissions. The auditing profession is currently operating in a very dynamic environment as numerous forces are affecting the responsibilities and activities of the public accountants. Lately, critics have charged that the current audit has failed to meet user expectations (e.g.: Enron case). Therefore it is important for the profession to reflect as to the nature and ethics of auditing in hope that by practicing ethically this will restore the

* Assistant Professor of Accounting, Dept. of Accounting, Faculty of Economics .&

Administration, King Abdulaziz University, Kingdom of Saudi Arabia. www.ybasudan.kau.edu.sa ** Professor (finance, insurance, investment, capital market & petroleum finance), Islamic

Economics Institute, King Abdulaziz University, Kingdom of Saudi Arabia. www.drmasumbillah.blogspot.com

1 Companies Act 2015, Ministry of Commerce and Industry, Saudi Arabia. Companies Act 1965, Malaysia.

2 Auditing and Assurance services in Malaysia, William F.Messier, Jr. Margaret Boh, McGraw Hill, Malaysia Edition, 2002, Pg 3


confidence of the public. The purpose of this term paper is to explore auditing under the Shari’ah guidelines. Perhaps the best solution to the above critics is by developing an auditing standard and guidelines with reference to the Shari’ah rulings.

Keywords: audit, Shari’ah, compliance, standard, corporation

Introduction Annual audit has been made compulsory for every company, which is registered

under the Companies Act, both in Saudi Arabia and Malaysia3. In contrast, a business registered as a sole proprietorship or partnership is not required to audit its annual statements annually. In addition, the acts also require that company’s annual audit must be performed by an external independent auditor. This is where the credibility of an auditor is enhanced through the public reliance on the professionalism of audit profession. Traditionally, the essence of auditing is to provide financial control and risk management. The Auditor is deemed to work on the interest of shareholders, by which he/she needs to carry out a systematic process with the objective of accumulating and evaluating evidences regarding the management assertions contained in the financial statements4. Hence, the auditor’s assurance depends on the level of collaborative evidences found during the audit process. However, there’s an increase in audit need since the corporate sector has expanded in parallel to the changes in business activity. Thus, audit provides not only control on financial aspects but furnishes top management with analysis, appraisals, recommendations and advices regarding the company‘s performance and profitability as well5. Moreover, it identifies business opportunities, which will then contribute to adding value across the business. Hence, the most important aspect is that audit serves as a method of corporate governance since audit analytical procedures provide extensive control on the correspondence between management assertions, its authenticity and financial reporting framework6.

3 Companies Act 2015, Ministry of Commerce and Industry, Saudi Arabia. Companies Act

1965, Malaysia. 4 Principles of Auditing: An Introduction to International Standards of Auditing, Rick Hayes,

Philip Wallage, Hans Gortemaker, Third Ed., Pearson Education Limited, United Kingdom, 2014.

5 Accountability, Corporate Social Reporting and the External Social Audit, Gray, R., D. Owen and K. Maunders (1991), iC.R. Lehman (ed.) Advances in Public Sector Accounting, Vol 4., 1991, pg 21.

6 OP. cit, Pg 23


Audit Function at Glance

Adapted from: Auditing and Assurance services in Malaysia, William F.Messier, Jr. Margaret Boh, McGraw Hill, Malaysia Edition, 2002 pg 4

Rational Outlook Auditing plays an important role in the process of providing objective and

independent reports on the reliability of information. Generally, by adding the audit function in business activity the users of the financial statements have reasonable assurance that the financial statements do not contain material misstatement. Hence, the users can rely on the assertions made by manager, while making any judgments or decisions. As mentioned earlier, auditing profession is operating in a very dynamic environment. There are many forces, which influence the responsibilities and activities of an auditor. Thus, complying to general accounting and auditing standards as well as Shari’ah rulings while expressing a reasonable assurance to the financial statements become the most important objective of an audit. Apart from complying with the aforesaid standards, there are some other standards, which an auditor has to keenly keep under observation; i.e.: Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI).7 This is to ensure that the activities carried are not in breach of the Shari’ah requirements. Ultimately, an audit on financial statements enhances the reliability of management assertions and enables auditor to communicate his true and fair opinion on the financial statements to the interested users or parties.

7 Accounting, Auditing and Governance Standards, Accounting and Auditing Organization

for Islamic Financial Institutions (AAOIFI), 2015.

Shari’ah Mechanisms of Audit


Organizational Structure of a Financial Statement Audit

Auditor’s Duty Auditing plays an important role in the principal-agent relationship, by which

auditor has a responsibility of determining whether the financial reports prepared by the manager conform to the approved accounting standards and comply with Companies Act. In general, audit is to enable the auditor “ to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework”. This is stated in ISA 200, “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance With International Standards on Auditing” (Para. 3)8. Thus, auditor’s opinion towards the financial statements adds credibility to the report. Auditing requires auditor to engage in a systematic process of accumulating and evaluating evidences, which relate to the management assertions in the financial statements. Auditor’s reliance on collaborative evidences will influence the auditor’s opinion towards the financial statements.

8 International Standards on Auditing (ISA), ISA 200, Para 3


Performing professional duties entails a lot of ethical procedural activities. It requires some commitments towards the responsibility, which is shouldered by an auditor. Serving clients to the best and offer management some valuable advices have been highlighted as the primary responsibilities of auditors. This includes a discussion on the current system used by the client. Auditor, who observes and evaluates the management system and control used, may provide value-added advices to his client. For instance, auditor may suggest the use of certain accounting software to the client who is using manual accounting system. To maintain the perception that auditors are credibly reliable in their profession, they should observe ethical values in their duty apart from providing the highest level of trustworthiness, integrity and truthfulness. All information should be disclosed and communicated to the related parties so that it will not reflect any wrong judgments. In addition, auditors should avoid themselves from taking any advantages of the client’s confidentiality of information, either for personal or third party’s interest.

The question of complying with professional ethics depends on the principle of religious legitimacy. Responsibility towards God (Allah) should be put as the priority in one’s consideration followed by responsibility towards society, profession, superiors, client and he himself. Commitment towards Allah generates good ethical appearance, diligent and proper work with high quality, which complies with Shari’ah rules and principles. This applies especially to the auditor, who is Muslim in religion. The emphasis on Shari’ah adherence provides good audit work through the sincerity while performing professional duties. Seeking Allah’s satisfaction becomes a due to good job fulfillment by way of being conscious to the accountability before Allah and the Day of Judgment. For instance, a good auditor will refrain himself from committing any corruption or convicting to any fraudulent activities such as accepting gift, favor or hospitality that would influence his judgment on the assertions contained in the financial statement.

Moreover, auditor is responsible to preserve his independence in either fact (mind) or appearance. Auditor should maintain his mental attitude of being fair and portray his independency. ISA 200 stated that, “the auditor be independent of the entity subject to the audit. . . . The auditor’s independence from the entity safeguards the auditor’s ability to form an audit opinion without being affected by influences that might compromise that opinion. Independence enhances the auditor’s ability to act with integrity, to be objective and to maintain an attitude of professional skepticism”9. This indicates that independence can be in term of mind as well as appearance. The earlier type of independence includes freeing an auditor’s mind from any factors, which will influence or affect his professional judgment. While the later type of independent refers to holding official position which disqualifies a person from being auditor for the particular company as stated in the Company Act. Apart, holding financial interest or having family relationship in the client’s company will disregard one to be the auditor of that company. In addition, auditor should adhere to general accounting and auditing standards while conducting any audit work, even up to the process of evaluating evidences and providing reasonable assurance to the financial statements. Besides, auditor should observe their competency and due care in the profession. It can be attained through updating his technical services and keeping his knowledge up to date. 9 International Standards on Auditing (ISA), ISA 200, Para A16



In conclusion, in the expanse of audit profession, auditor should continuously be aware and observe his function and responsibility towards Allah, society, profession and client in providing a true and fair view on the financial statements through serving client to the best and with the most ethical conduct, which should not contravene the underlying principles.

In short, auditor’s responsibilities include to: • Determine whether the financial reports prepared by the manager conform to

the approved accounting standards and comply with Companies Act.

• Add credibility to the report of financial statements.

• Engage in a systematic process of accumulating and evaluating evidences, which relate to the management assertions in the financial statements.

• Serve clients to the best and offering management valuable advices.

• Observe ethical values in their duty apart from providing the highest level of trustworthiness, integrity and truthfulness.

• Put emphasis on Shari’ah adherence to provide good audit work through the sincerity while performing professional duties.

• Preserve his independence in either fact (mind) or appearance.

• Adhere to general accounting and auditing standards while conducting any audit work, even up to the process of evaluating evidences and providing reasonable assurance to the financial statements.

Auditor should continuously be aware and observe his function and responsibility towards Allah (swt), society, profession and client in providing a true and fair view on the financial statements through serving client to the best and with the most ethical conduct.

Agency Relationship Affecting Audit*

*Source : Auditing and Assurance services in Malaysia, William F.Messier, Jr. Margaret Boh, McGraw Hill, Malaysia Edition, 2002 pg 16


Audit and its Shari’ah Guidelines

Islam is a comprehensive religion. It provides guidance in all aspects of life including economics, social, political and cultural. Accounting and auditing are parts of economy, which are professions that are required by Shari’ah as Fard kifayah. Both accounting and auditing provide the concept of fairness as they show where the resources have been allocated. The realization of this concept is closely related to the code of ethics for accountant in performing their professional duties and responsibilities. From the Islamic point of view, the ethics of accountants and auditors depend primarily on the principles of Islamic faith and Shari’ah. As ethics are an integral part of Islamic Shari’ah, therefore, Islam strongly emphasizes on that and considers them as one of the objectives of legislation. In short, Islamic Shari’ah provides some foundations of auditors and accountants’ ethics. The major Shari’ah foundations of auditors and accountants’ ethics are as the followings: -

Integrity10

Integrity is an act of honesty and having strong moral principle. In Islam, integrity is highly valued as it governs all acts. It requires accountants and auditors to perform their duties and responsibilities with competency and adequacy. Allah says in the Qur’an,

“Truly the best of men for thee to employ is the man who is strong and trusty”. (Surah Al- Qasas: 26)

Principle of Vicegerency11 Man is the best creation of God (Allah) and Allah has bestowed us with mind (al-

aql). Thus, we serve as vicegerent of Allah. We are entrusted to develop the earth. However, it is important to be aware that the supreme authority belongs to Allah, and that man’s ownership of property is not absolute. We must always observe the orders and prohibitions of Allah regarding property. Objectives in Shari’ah are pervasive and this includes property. Thus, auditors have big roles in making sure that property and funds are not squandered and wasted uselessly or used in prohibited matters (e.g. usurious transactions) or traded unjustly or by denying the rights established in it for Allah. Anything that is prohibited in Shari’ah should not be given neither verbal nor documentary support in anyway whatsoever. Allah says in the Qur’an;

“Behold, thy Lord said to the angles: “I will create a vicegerent on earth”. (Surah Al Baqarah: 30)

“It is He who hath made you (His) agents, inheritors of the earth”. (Surah Al

An’am: 165)


for Islamic Financial Institutions (AAOIFI), 2015, Pg 1010 11 Accounting, Auditing and Governance Standards, Accounting and Auditing Organization

for Islamic Financial Institutions (AAOIFI), 2015, Pg 1011



Sincerity12

The Qur’an and Sunnah stress that in what ever we do, we must have good intentions. Good intentions will lead to good performances and commitments in work as they also promote sincerity and avoid hypocrisy. Auditors are not to perform work because of fame, flattery and boasting. Instead, he should regard his work as a religious commitment as well as a performance of his professional duty. This will eventually turn his duty into a form of worship. This is line with the fundamental established in Shari’ah that good intention turns a habit into worship. Subsequently, the auditor becomes worthy of reward from Allah.

Piety13

Piety is refers to a strong belief in religion. It means fearing Allah to protect one’s self from adverse consequences with rules of Shari’ah. This is done by observing Allah’s commandment and to forbid oneself from His prohibitions. Therefore, auditor has to fear Allah in performing his duty especially when dealing with property as it diverts man’s attention and leads him into transgression. As Allah says:

“Let there arise out of you a band of people inviting to all that is good, enjoying what is right and forbidding what is wrong”. (Surah Al- Imran: 104)

Then the Holy Prophet also mentioned that,

“Fear Allah wherever you are, and follow the evil with good to obliterate it, and deal with people in good conduct”.

Righteousness and making one’s work perfect14

According to this principle, one should perform his duties that have been assigned to him in the best manner and that is to attain perfection in his work. This can be achieved through academic qualifications, practical experience and acquisition of religious knowledge. Therefore, auditors must always strive to acquire the above. Allah promotes this principle in the Qur’an:

“And spend of your substance in the cause of God, and make not your own hands contribute to (your) destruction; but do good, for God Loveth those who do good”. (Surah Al Baqarah: 195)

Besides that, Prophet (saw) also mentioned that;

“Allah likes when someone performs his work to do it perfectly and Allah has described righteousness in everything”.


for Islamic Financial Institutions (AAOIFI), 2015, Pg 1012 13 Ibid, Pg 1012 14 Accounting, Auditing and Governance Standards, Accounting and Auditing Organization

for Islamic Financial Institutions (AAOIFI), 2015, Pg 1013


Allah-fearing conduct in everything15

This implies that Allah is constantly watching the acts of His servants. Therefore, it is Allah that the auditors should be afraid of regardless of the opinion of people, which includes his superiors. This principle is absolute and will never change from time to time. Hence, auditors should always practice self-monitoring. And this may weaken unless it is tied to both faith and feeling that one is being observed by Allah. Allah says;

‘Allah ever watches over you” (Surah Al Nisa’: 1)

For verily He knoweth what is secret and what is yet more hidden” (Surah Taha: 7)

Men’s accountability before Allah16 Since Allah is observing all the acts of an auditor, therefore, he will be accountable

to Him on the Day of Judgment for all his deeds. Thus, auditors should always be aware and to avoid doing things that may incur Allah’s punishment. The auditor should always remember that he is accountable before Allah, and before his society, profession, superiors and finally before himself.

“Then shall anyone who has done an atom’s weight of good, see it. And anyone who has done an atom’s weight of evil, shall see it” (Surah Al Zalzalah: 7-8)

Shari’ah’s Code of Ethics in Auditing Auditing is one of the branches of accounting. It is associated with examination of

accounting data. It is a professional service which people put high reliability on. Hence, audit needs to be performed in the most ethical manner since the auditors provide reasonable assurance to the company’s stakeholders. Therefore, based on the ethical principles highlighted in the Qur’an and Sunnah, the following ethical principles for accountants and auditors are derived17: -

Trustworthiness Accountants and auditors should be trustworthy and honest in conducting their

professional duties. However, they are said to be trustworthy by conducting their responsibilities with high degree of integrity and honesty. One way to show their integrity is by protecting client’s interest, which is related to the confidentiality of the information of the clients. For example; they cannot use such confidential information for their personal gain and third party. Besides that, the auditors have to present and provide factual and truthful report so that others can rely on the information while making judgement and decision.




for Islamic Financial Institutions (AAOIFI), 2015, Pg 1016-1017



Legitimacy Besides being truthful and honest, auditors also have to comply with certain legal

requirements and procedures including the Shari’ah rules and principles. They have to act and conduct according to the guidelines of Shari’ah principle. Moreover, they also have to comply with standards provided by professional bodies.

Objectivity In conducting an audit work, auditors have to be objective. They have to perform

their professional duties in fair, impartial and unbiased ways. They also have to be free from any conflict of interest in order to ensure their independence. Since independence is a fundamental characteristic and key point of auditing profession, auditors should be independent both in mind and appearance. If the auditor is a member of the board of directors of the auditee company, then, he should not perform or conduct any audit work for that company. This is because he could be involved in providing bias information, as now he is no longer an independent party.

Professional competence and diligence Since auditing is a professional service, it should be conducted in professional

ways. Therefore, auditors should show their credibility in realizing these duties. To ensure work is done in proper manner, they should be professionally competent and well- equipped in carrying out the task assigned. Hence, professional competence can be achieved or obtained through ways like formal education, training, experience and professional education. Besides that, they have to be duly diligent in discharging their responsibilities as they are not only responsible to the stakeholders but ultimately also to Allah the Al-Mighty.

Faith-driven conduct Auditors should behave and conduct his duties in line with the faith values derived

from Shari’ah rules and principles.

Applications Application of ethical conduct based on the principle of trustworthiness

An auditor should refrain oneself from engaging in any activity that would jeopardize the attainment of the institution’s religious and ethical objective. Therefore, an auditor should present and communicate favourable as well as adverse information honestly with complete transparency. He should not disclose confidential information acquired in the course of performing professional duties unless required to do so by the law. He also should not use the information acquired in the course of his duties for the advantage of himself or third parties.

Application of ethical conduct based on the principle of religious legitimacy

An auditor should always remember his responsibilities towards Allah, and towards his society, profession, superior and himself. Therefore, it is his responsibility to verify


the religious legitimacy of everything relating to his duties. He should be aware of Shari’ah rules and principles relating to jurisprudence of financial transactions. Thus, he should receive formal, adequate training in jurisprudence of financial dealings. He must make sure that he performs his duties in conformity with such rules and principles. Anything that is not in conformity with Shari’ah should be considered illegitimate.

Application of ethical conduct based on the objectivity principle An auditor should be independent in fact as well as appearance. Therefore, he

should not involve himself in a situation whereby there is a conflict of interest. This is because it will threaten his judgment in expressing his opinion. He should also avoid from being influenced by others to ensure he could present information truthfully. In his course of duties, he should refuse any gift or favor. Contingent fees (defining the fees as a percentage of the income number) should also be avoided as it might affect the independence and objectivity of the auditors.

Application of ethical conduct based on the professional competence and diligence principle

An auditor has a responsibility to possess an appropriate level of academic and professional competence. He should uphold his competence by going through skills development constantly and keeping himself updated with the new developments in the auditing as well as accounting profession. Most importantly, he should acquire sufficient working knowledge of Shari’ah aspects relating to financial transactions.

Application of ethical conduct based on the principle of faith-driven conduct

An auditor’s behavior should always be in line with religious values derived from Shari’ah rules and principles. Particularly, he should consistently do self-monitoring (that is always being aware of the existence of Allah (swt). He should be conscious that he is accountable before Allah on the Day of Judgment. Therefore, in his course of duties, he should be seeking Allah’s satisfaction and not to submit to the pressures of others. He also should show love and brotherhood as well as be merciful to the rest of the staffs and whomever he deals with.

Auditor’s Report The auditor’s report is the expression of opinion of the auditor whether the

financial statements audited present fairly the financial position and the result of operations, and have been prepared in accordance with the applicable accounting standards. It is also important to note whether the financial statements comply with the statutory requirements.



The auditor’s report consists of:18

Title E.g. Reports of the Auditors Addressee

The report should be addressed mainly to the shareholders/members of the company audited (as required by the engagement and laws).

Introduction The report needs to identify the financial statements that have been audited and its

notes as well as the date and period covered. There should also be statements regarding the responsibilities of the management and those of the auditors. The management’s responsibility is towards the preparation of the financial statements. Meanwhile, the auditor’s responsibility is to express an opinion on the financial statements.

Scope Paragraph The reports should narrate that the audit was conducted in accordance with the

relevant auditing standards and accounting principles, which do not contravene the Shari’ah Rules, and Principles. The report should also indicate that the audit was planned and performed to obtain reasonable assurance and not an absolute one. The audit also evaluates the overall financial statement presentation.

Opinion Paragraph The auditor’s report must state the auditor’s opinion as to whether the financial

statements give a true and fair view in accordance with the appropriate standards that do not contravene with the Shari’ah rules and principles and statutory requirements.

Auditor’s Address and Signature The report should name the audit firm, personal name of auditor and address of the

audit firm. The report should be signed.

Date of Report The auditor should date the report at the date when the audit was completed. The

date should not be earlier than the date on which the statements are signed or approved by management.

18 Auditing and Assurance services in Malaysia, William F.Messier, Jr. Margaret Boh,

McGraw Hill, Malaysia Edition, 2002, Pg 503


Audit Process

Recommendations Lately, critics have charged that the current audit has failed to meet user

expectations. It is important for the profession to reflect as to the nature and ethics of auditing in hope that by practicing ethically this will restore the confidence of the public. In order to uphold the integrity of auditors, a separate body should govern ethical principles governing the auditor’s professional responsibilities. Therefore, the best solution is to form the Shari'ah Supervisory Board to govern the ethics of auditors. The ethical principles that should be included are:

• integrity

• trustworthiness

• confidentiality



• professional behavior

• honesty

• righteousness

• fairness

• objectivity

• professional competence

• due care

• independence etc

The question of complying with professional ethics depends on the principle of religious legitimacy. Responsibility towards Allah should be put as the priority in one’s consideration. Commitment towards Allah generates good ethical appearance, diligent and proper work with high quality, which complies with Shariah rules and principles. The emphasis on Shari’ah adherence provides good audit work through the sincerity while performing professional duties. Seeking Allah’s satisfaction becomes a due to good job fulfillment by way of being conscious to the accountability before Allah on the Day of Judgment.

Conclusion Annual audit is mandatory for every company, regardless of size, that is registered

under the Companies Act. An auditing plays an important role in this process by providing objective and independent reports on the reliability of information. Traditionally, the essence of auditing is to provide financial control and risk management. Auditor is deemed to work on the interest of shareholders, by which he/she need to carry out a systematic process with the objective of accumulating and evaluating evidences regarding the management assertions contained in the financial statements. However, there’s an increase in audit need since the corporate sector has expanded in parallel to the changes in business activity. Thus, audit provides not only control on financial aspects but furnishes top management with analysis, appraisals, recommendations and advices regarding the company‘s performance and profitability as well. Thus, complying to general accounting and auditing standards as well as rulings issued by Shari’ah Supervisory Board while expressing a reasonable assurance to the financial statements become the most important objective of an audit. This is to ensure that the activities carried out are not in breach of the Shari’ah requirements. Ultimately, an audit on financial statements enhances the reliability of management assertions and enables auditor to communicate his true and fair opinion on the financial statements to the interested users or parties. To maintain the perception that auditors are credibly reliable in their profession, they should observe ethical values in their duty apart from providing the highest level of trustworthiness, integrity and truthfulness


References Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)

(2015) Accounting, Auditing and Governance Standards, Dar AlMaiman for Publishing & Distributing.

Companies Act (1965), Malaysia.

Gray, R., Owen, D. and Maunders, K. (1991) “Accountability, Corporate Social Reporting and the External Social Audit”, I.C.R. Lehman (ed.) Advances in Public Sector Accounting, Vol 4, pg 21.

Hayes, Rick, Wallage, Philip, Gortemaker, Hans (2014) Principles of Auditing: An Introduction to International Standards of Auditing, Third Ed., Pearson Education Limited, United Kingdom.

International Standards on Auditing (ISA), ISA 200.

Messier, William, Boh, , Jr. Margaret (2002) Auditing and Assurance services in Malaysia , McGraw Hill, Malaysian Edition.

Ministry of Commerce and Industry (2015), Companies Act, Saudi Arabia.



The Significance of Faith-based Ethical Principles in Responding to the

Recurring Financial Crises By

Dr. S Nazim Ali,Ph.D*.

Professor Shariq Nisar,Ph.D Abstract: The global financial system has been under tremendous pressure due to recurring financial crises. With nearly every major economy affected, the cost of managing these crises has been enormous. Some studies have identified ethical failure as the root cause of these financial crises, while others have focused on the structural flaws in the system. While both the diagnoses may be correct, the prescription for handling the crises lacks clear direction and consideration for its applicability over the long run. This paper focuses mainly on the ethical aspects and recommends a few long-term measures that seek to improve moral behavior. Few suggestions have also been made to improve financial inclusion based on common religious, social and moral values.

Key Words: Islamic Finance and Stability; Faith-Based Finance: Ethics and Morality

1. introduction The global financial system has been under tremendous pressure in recent years,

affecting many major economies of the world. Due to the interconnected nature of the world economy today, financial crises occurring at one place can quickly engulf other economies. As a result, many economies have suffered enormously due to diversion of precious financial resources to keep the financial system working, not to mention the tremendous suffering and the loss of opportunity. Many can recall when similar crises struck less developed or developing countries (like the four “Asian Tigers”), most financial gurus deemed it a symbol of the structural weakness of those economies. We started taking these challenges seriously only when big and developed economies started * Authors: Dr. S. Nazim Ali, Ph.D., Research Professor & Director, Center for Islamic

Economics &Finance, Hamad Bin Khalifa University, Doha Qatar. Professor Shariq Nisar, Ph.D., Professor,Rizvi Institute of Management Studies and Research, Mumbai, India


feeling the dominant effect of such crises despite strong regulations in place. The period following the 2008 financial crisis witnessed decelerating growth in many developed economies (US economy contracted by -0.7% in 2009 while the UK was the worst affected of Western European countries with a contraction of -1.3%). We have seen how even strong regulations are not sufficient to insulate economies from being impacted by economic shocks.

A number of structural causes have been identified by various experts (Rajan, 2010). This paper concentrates on the ethical aspect, in particular on dealing with human greed and mischief. The importance of an ethical compass is emphasized by recognizing the fact that after the crisis, the alpha of Social Responsible Investments(SRI) funds, compared to other mutual funds, turned positive(Nieuwenburg,2013).The culture of greed is believed to be one of the main causes leading to financial mischief and ultimately to financial crises over time. Policy makers have to address the fallout of unlimited greed, lack of honesty, selfishness, among others which the recurrent financial crises have revealed. The ‘greed-is-good, greed is right, greed works’ mentality is encouraged in modern financial institutions, but it comes mainly at the expense of consumers and suppliers and the society at large. Customers tend to be the most exposed to risk as they rely almost entirely on the financial service providers. Contrary to their interests, we observe concerted efforts by many stakeholders in the financial system to lure customers into making risky investments. Banks employ shadow banking strategies; rating agencies have often missed the bigger picture, focusing on the wrong metrics; and regulators are found wanting in discharging their responsibilities as the market achieves greater sophistication. According to the Financial Stability Board, shadow banking has become an increasingly popular phenomenon with assets mounting to over $80 trillion as at 2014 with nearly 200% growth between 2002 and 2014(FSB,2015). Another case in point of this phenomenon was clearly evident in the case of the Subprime Mortgage Crises (SMC) in 2008. It is well known now that home loan seekers were tricked into housing mortgage. . Art Perlowrites, “the subprime mortgage crisis is the trigger that has set off a whole number of financial imbalances — it triggered the whole pile to start falling. This crisis was caused by incredible greed and looting by the financial sector….” (Webb, 2007).

The World Economic Forum Report on Faith and the Global Agenda: Values for the Post-Crisis Economy reported, “the majority of people across the globe believe the global economic crisis is related to ethics and values” (World Economic Forum, 2010). In addition, it has been shown that religiosity, ethics and values among corporate workers mitigate unethical behavior of a Corporation as a whole (Grullon, Gustavo, Kanatas, George, and Weston, James, 2009).

This paper is organized into four sections. After this introduction, section 2 attempts to diagnose the causes of recurring financial crises. Section 3 explores the significance of common platforms in reshaping and enhancing best practices in the global financial system. The final section concludes with some policy recommendations.

2. Diagnosing The Causes Of Recurring Financial Crises While many studies have focused on the probable causes of financial crises, this

paper identifies two major factors that are directly related to the central hypothesis of this

The Significance of Faith-based Ethical Principles….


paper. Lack of access to financial information for consumers, and regulatory gaps and loopholes in the penalty systems for financial misconduct are the two important causes.

2.1 Lack of access to financial information for consumers Poor financial choices due to lack of relevant information has been a major

contributing factor to financial crises (European Commission, 2010). Unequal access to information in respect of financial products constrains use and development of a just and stable economy (Lumpkin, 2010). Consumers may not be well-educated or well versed in financial matters to comprehend financial innovations. As Organization for Economic Co-operation and Development (OECD) points out:

“With the rapid pace of financial innovation, the growing complexity of financial products, and the increasing amount and size of financial risks and responsibilities transferred to households, it has become very difficult for the average consumer to successfully navigate the financial marketplace, let alone for poorly informed individuals” (OECD, 2009).

Financial institutions are also criticized for lacking a sense of social responsibility. Their focus on the profit maximization comes at the expense of consumers, as the disclosures are either insufficient or too complex (Brix et al, 2010). Financial institutions should be required by law to remain transparent. . Regulatory authorities should intervene to ensure that no deception or tricks are used to unfairly attract consumers and key features including the risk factors are revealed to consumers in the language that is understandable for ensuring transparency and clarity.

2.2 Regulatory Gap/Overlap and Loopholes in Penalty Systems for Financial Misconduct Penalties, though in place, have been inadequate in curbing fraud and misconduct.

This poses serious problems for the checks and balances mechanism. Firms have become more sophisticated in their dealings with the penalty systems, implementing a cost-benefit analysis, to get their way around the system. Many big companies consciously violate the law because the profits they reap in doing so are far greater than the fines they might have to pay in case they get caught. (Durden, 2013) (Raice, 2013).

3. EXPLORING COMMON PLATFORMS 3.1 Ethics and Morality

Historically most financial crises exhibit similar patterns and are triggered by almost the same factors (Mian, Atif and Sufi, Amir, 2014). Structural flaws in the financial system as argued by many experts are no doubt inherent which to a large extent could be addressed by policymakers and regulators (IMF, 2012). Masses in general have little role to play in that, but efforts to improve financial literacy with high emphasis on morality in financial systems will go a long way in addressing the challenges of morality in the financial world. Inculcation of good moral values and conduct, developing a sense of social responsibility, transforming the culture and instilling the right type of education among the budding entrepreneurs and financial players could help the future of the financial system in a very positive way.


The most important challenge in this regard is how to encourage people to behave

ethically and morally. Very often we notice the lack of incentives for those who behave well. Contrarily, those who cross the line are often seen climbing the ranks rather quickly. There is a need for an effective mechanism to address this anomaly. A system is needed where good behavior can be objectively measured and appropriately rewarded at the same time any type of malfeasance is not only restricted but also punished.

Transformation of beliefs, attitudes and mindsets of financial participants across all levels are hoped to bring about greater financial stability. On the other hand provision of rewards and penalties hope to bring greater coherence in compliance with law in its true spirit. Moreover it is felt that the main reason for financial exclusion of a vast majority of people across the globe is not really the lack of resources but the lack of spirit and motivation. Unfortunately, it is generally believed that the current financial system has led to more exploitation and misallocation of financial resources thereby making the rich the greatest beneficiaries (Oxfam 2015).

One cannot ignore the fact that despite having the best of infrastructures ever in human history, modern economy has not been able to show compassion towards the poor, vulnerable and marginalized.

3.2 Ethics, Religious Teachings and Faith Ethics form a greater part of religion and most of the religious beliefs today have

enormous ethical injunctions that followers must adhere to (Dhand, 2002 and Akpinar, 2010). Virtues of loving, kindness, compassion, abstinence from killing, stealing or lying are sacrosanct in Buddhism. In Christianity similar ethical values such as love, mercy, and forgiveness and virtuousness in thoughts and actions are emphasized. Islamic teachings hold high the ethical ethos of justice, mercy, goodness, compassion, avoidance of wastefulness, forbiddance of evil, etc. It is observed that there is good overlap of the ethical values among religions pointing to the universal nature of ethical behavior.

All the Major religions of the world recognize the role of ethical behavior in practice by sharing almost a similar stance on the areas of SRIs. (Bhatt, Sultan, Shah, 2014).

There is a need to establish a common ground that will spell out a code of conduct and establish an agreed-upon ethical system in financial dealings. One way this could be done is by basing it on religious teaching and values which enforces a code of conduct on its followers. A case in this regard that is worth mentioning is the Emotional and Spiritual Quotient (ESQ) training program in Indonesia introduced in the early 2000s. The idea is the combination of business management, life-coaching, and self-help principles with Islamic history and examples from the life of the Prophet Muhammad (Rudnyckyj, 2009). The ESQ is designed to realize a form of effective self-management by making ‘people better from the inside’. Similar actions were taken by some movements who cited separation of religious ethics from economic practice as the main cause of the economic ‘crises’ in Indonesia. They opined that this demerger has resulted in rampant corruption, inefficiency, collusion and a lack of discipline in the workplace. This phenomenon is not limited only to Indonesia, but is increasingly found elsewhere in the world (Haenni 2005 and Wise 2003).



There are two competing theories regarding the link between economic growth and religion. The first, known as the secularization hypothesis, (Weber, 1930) postulates that greater economic development causes individuals to abandon their faith and become less religious. This hypothesis also claims that economy as it becomes stronger plays a larger role in the governance of the country than religion. The other theory (Smith, 1790) claims that as a society becomes religiously diverse, the different religions compete which results in stimulating more interest in religion. The latter hypothesis is strengthened by the study of Chaves and Cann (n.d.) who have shown that greater governmental sponsorship of religion paradoxically decreases the individual’s interest in religion. A survey conducted in the United States shows positive relationship between religiosity and poverty.

On the other hand, in some societies, notably among the communist societies, religion is considered as “the opium of the masses”, and thus religious freedom and diversity are suppressed by state as a policy. The above mentioned theories examine religion as an outcome of economic development or policy; comparatively little research (Barro and McCleary, 2013) has been done on religion as an antecedent to economic growth. Alon and Chase (2005) examined political and economic freedoms alongside religious freedom in explaining economic prosperity and found that religious freedom is a significant antecedent of economic prosperity.

Adding to the points on overlap of religious values, it is argued that most of the faith based financial models, be it, Judaism, Christianity, Islam, Hinduism or Budhism, share common goals such as the upliftment of labor and the downtrodden sections of society, abhorring violence, shunning vulgar entertainment etc. These common goals can be conveniently converted into actionable plans in the form of Corporate Social Responsibility, Corporate Governance, Human rights and the care for Environment.

Indeed, there have been clear calls advocating financial regulators to revisit the teachings and wisdom of various faith based traditions in staving off future financial crisis (Steele, 2010). Across religions there are activities which are prohibited or abhorred like interest, gambling and businesses which are discouraged for causing harms to society. At the same time, there are also activities which are encouraged like sharing of risk, helping the poor and needy and donating to charities to help the underprivileged.

There are also religiously sensitive investment strategies that are important in creating a common platform based on religious teaching and values. For example, the practice of excessive and highly speculative risk taking, especially in as much as they are of such a scale that they increase the level of systemic risk, must be examined and monitored in terms of their potential impacts on the common good. In the same way the impacts of the use of derivatives, credit default swaps and other activities such as short selling on the stability and soundness of the financial system and therefore the well-being of communities across the world must be examined and evaluated.

The question one may ask is: How will faith and religion play a part in fostering a common platform in the financial industry? There are several ways this can be achieved. Firstly, faith-based teachings reintroduce the foundational belief and value that gives more emphasis on sustainability than short term profit (Kaye, 2012).A system that has its priorities set over serving the needs of all communities before enriching executives,


traders and shareowners will be consistent with the vision of the faith traditions. This system will earn confidence of people and hence is more inclusive.

Secondly, faith and religion serve as a reminder to the business and investment community of their responsibility toward the future of Earth and its sustainability for future generations. Financial and economic decisions based on values taught by the religious systems will serve as a moral compass for business community and investors (Chapra, 1995).

Thirdly, religion allows their followers to integrate their beliefs into the management of their financial and commercial affairs. In this innovative space many faith traditions have established funds and innovative credit mechanisms that reflect more faithfully their foundational principles on the practice of credit, borrowing and lending while preserving wealth and posterity. The National Council of Churches, for example, has undertaken shareholder activism, social-purpose mutual funds and the like since the 1970s. Such initiatives are pertinent examples of the integration of Christian beliefs into the financial and commercial aspects in the lives of believers.

Fourthly, religious faiths working together can draw on the principles they hold in common to promote a more humane system and reform the dominant financial system. By working together, they can bring the values of sustainability, social responsibility, and solidarity into a vibrant debate and conversation about the kind of economic model that is consistent with the vision of their beliefs. In the post-World War II period, for instance, we have examples of the modification of a free market individualistic capitalism to a more socially oriented market economy, especially European markets where mutual and cooperatives are more prominent (DGRV Die Genossenshaften, 2016.). Mutual and cooperative insurance accounts for over a quarter of the global market, and is the fastest growing sector of the market (ICIMF, 2014).

Finally, the faiths can likewise find common ground with others in the ongoing process of evaluating the tools and innovations that are introduced into financial system by using the wisdom in their traditions and the environmental, social and governance (ESG) criteria that have been established. For example, using the precautionary principle from risk management in a financial setting may be useful (Schettler, Barrett and Raffensperger, 2002).

As argued above, religious teachings and faith can facilitate the creation of common grounds for financial stability, inclusiveness and sustainability by establishing a more inclusive and morally conscious system rather than conducting financial transactions that merely adopt a legalistic attitude to financial regulation. The idea of faith-based ethical economies has now been espoused by all major faiths. Below we quote various religious experts which clearly indicates the commonality of thoughts on the subject.

Leading Islamic finance expert, Justice Muhammad Taqi Usmani argues:

“The crisis we are facing is not caused by some regulatory mishaps only; there are some systemic errors in our conceptual framework. This framework needs a revival of some noble values and a serious review of some basic principles on which we have constructed the whole edifice

The Significance of Faith-based Ethical Principles ….


of our economy. There are two basic values of foremost importance that must be reflected in a balanced, sustainable and just economy. First, the common welfare of the society should take precedence over individuals’ selfish objectives. Second, the profit motive should not be extended to unlimited greed of wealth” (Usmani, 2009).

The element of social welfare based on common good as espoused above is also emphasised by Lesley-Anne Knight, Caritasof theVatican City, who contends that:

“During the course of the 20th century, the Catholic Church elaborated a clear set of social values that are increasingly relevant today as we consider the kinds of institutions and governance mechanisms we need to ensure a more humane global economy” (Knight, 2010).

Ensuring a more humane global economy requires sustainable practices that promote equity, fairness and justice without compromising the aspects of environmental conservation. YukeiMatsunaga of the Japan Buddhist Federation argues that:

“….an emphasis on the interdependence of all living things—the vision of life taught in Japanese Buddhism—may provide effective suggestions for handling such pressing issues of modern society as human alienation and environmental destruction”(Matsunaga, 2010)

Rabbi David Rosen of the American Jewish Committee contends:

“If enterprise and industry are detached from the human connection, then they will not be sustainable in the long term. Moreover, in order for there to be a common language—in the deeper sense of the term—that connects the various components of society, it is necessary for the members of that society to have a sense of the transcendent, a sense that there is something more to their existence and activity than purely “the edifice itself”” (Rosen, 2010).

This eschatological basis should be the driving force that will trigger a sense of

care and common good in the society. Rev. Katharine JeffertsSchori, the Presiding Bishop of the Episcopal Church believes that:

“this ethics of care for the least applies to all the major issues facing us: local, national and international economic praxis; ecological and climatic concerns; and the structure of the global market” (Schori, 2010).

The way forward requires concerted efforts among all the stakeholders in promoting shared human values in financial matters. To this end, Sri Ravi Shankar argues that:

“the implementation of these human values in the corporate program…has to be developed holistically by including society’s four pillars: its economic establishments, its faith-based organizations, its political institutions and its social sector…Faith-based institutions can catalyze a huge transformation and engender much needed integrity in people” (Shankar, 2010).


There should be a way of minimizing the effect of greed in personal behavior.

Reverend Dr Olav FykseTveit, the General Secretary of the World Council of Churches explains:

“Economic laws and principles from beginning to end are also a matter of personal behaviour. Because of the financial crisis, the attitude of greed now has a new face and new dimensions…We will never experience the total disappearance of greed. However, we can work together to define what kinds of attitudes build a sustainable global economy in a sustainable global community” (Tveit, 2010).

Building a sustainable global economy requires long-term plan that will take into consideration several factors, particularly the shared values. This is expected to transform the current socioeconomic model and make it more productive. Kirill I, Patriarch of Russia contends:

“without a solid basis in values, however, any transformation of the existing socioeconomic model cannot be productive. A feasible new model of global development should be based on the principles of justice, efficiency and social solidarity” (Kirill, 2010).

3.3 Culture and Society Various cultures and societies have inherited common values imbibed from their

religious teachings. The way of life, system of beliefs and thoughts of every society forms the social fabric of the community. Creating awareness of cultures around the world helps to build mutual respect and a sense of social responsibility amongst people. Many multinational corporations today tend to adopt the culture of the local environment they are operating in as they recognize how useful these values are for their business prospects. This idea is captured in The Business of Humanity project currently undertaken by the University of Pittsburgh, which seeks to improve strategic decisions made in organizations. It proposes that:

“Strategic decision making that employs criteria falling under the rubric of "humanity" - in its two dimensions of "humaneness" and "humankind" - leads to superior economic performance. Humaneness in business decision-making focuses on criteria and programs related to safety, quality, diversity, environmental sustainability, gender equality, social sustainability, integrity, ergonomics and good design”(University of Pittsburgh, n.d.).

3.4 Education Advancement in education and technology is leading to greater awareness about

environment and inspiring people to adopt more environmentally friendly mechanisms such as ethical, green and SRI movements, etc. Besides the focus on management processes and the technicalities of finance, an integrated education system which inculcates values and ethics to students is also important (Mian and Sufi, 2014). Excellence in business and finance education is about creating value not only to the economy and financial industry, but also to society and contributing to sound economic growth, improving human conditions and balancing between social and economic needs. Management education should focus on deep study of universal laws, philosophy and ethics.



In addition, the syllabus taught in educational institutions should be reviewed to include a component of ethics and morality (Kabir, Rasem, Oseni, 2013). For example, since September 2014 financial education has formed part of the compulsory national curriculum for all maintained schools in England. Students of finance are usually taught the subject with focus on how they could maximize returns. It is not wrong to pursue profit but it should always be reinforced upon them to look at their role and responsibility as financial intermediaries for the general sections of the population who are financially less educated and more vulnerable.

3.5 Environment Nowadays investors do not just look at their cash flows, but are also concerned for

how these cash flows are generated. Many investors abstain from investing in firms that use child labor or adopt heavily polluting technologies (Schwegler and Reutimann, 2014).The investors today distinguish between “sin stocks” and clean investment opportunities (Hong, Kacperczyk, 2009).

There is also an increasing level of awareness of firms to engage in socially-responsible and environmentally-friendly business practices. There have been widespread efforts in the incorporation of sustainability in the strategic vision of many financial institutions, realizing the importance of enabling the future generations to also benefit. For example, The World Bank has already established its own sustainability initiative called Wealth Accounting and the Valuation of Ecosystem Services (WAVES), which seeks to promote accounting methodologies that place value on the environment. Many ecosystems have placed tangible value in the form of tourism, drug development, natural disaster prevention, etc. In new methodologies, environmental assets would be included when calculating GDP.

3.6 Socially Responsible Investments Socially responsible investing, also known as “sustainable”, “socially conscious”,

“green” or “ethical investing”, is a kind of investment strategy which seeks to consider both financial return and social good. These investors encourage corporate practices that promote environmental stewardship, consumer protection and human rights. They avoid businesses that sell or promote alcohol, tobacco, gambling, pornography, weapons, contraception/abortion, fossil fuel production, etc. According to data from the Social Investment Forum Foundation.socially responsible investing nearly quintupled in the U.S. from 1995 to 2010 as measured by the amount of professionally managed dollars invested, growing from 9 percent to 12 percent of the national total. The rise of socially responsible investments could be an indicator of the growing importance of ethics and other social aspects in finance and Statman (2004) and Bollen (2007) opined that investors benefit from some utility from the externalities of investing in a way that is consistent with their beliefs.

4. Conclusion And Policy Recommendations Financial crises have been primarily a result of the personal, organizational and

ethical failures of not only financial players but also of the regulators and other players in the financial system. This paper attempted to highlight some of the important common teachings of various religious communities and how some emphasis on them could help to shape a better financial system that is more inclusive, stable and efficient.


Ethical values represent a general theme that runs across various faith based

communities, which eventually led to the introduction of SRIs. Similarly, the Islamic concept of economics is built on ethical business practices that promote justice, equity, and fair distribution of economic and financial resources.

Incentivizing good behaviour is a way of rewarding firms which practice sustainable and socially responsible decision making. One such measure of incentives is by creating public ratings of well-performing and outstanding companies, which have been serving their clients well, on a fair and transparent basis, and avoiding any acts of malfeasance as far as possible. Such ratings are intended to give these companies a better business standing and increased business prospects.

Financial crises may be as a result of financial mischief and criminal acts that go unnoticed over extended periods of time. This financial misconduct will be controlled by creating awareness and setting strong precedents of exemplary punishment to the guilty. To address this problem, we could create a rating database for financial executives just like the database for borrowers for analyzing their credit history.

Rating is a public good just like regulation; leaving it in private hands creates a strong conflict-of-interest situation. Therefore, rating systems should be publicly funded and executives made accountable for their actions. They should work in tandem with regulators. Also, companies engaged in financial businesses should be rated based on their compliance performance. A company or its shareholders/employees/directors punished for any misconduct should not go unnoticed for the purpose of regulatory compliance and cumulative rating. Companies falling short of the minimum cumulative rating should not be allowed access to public funds.

Central Banks are better equipped to deal with macro prudential regulation. Their intimate knowledge and experience provides them the ability to understand the impact of the failure of individual institutions on the financial system. However, there are also concerns over the conflicting targets that arise when central banks are mandated with responsibilities that are in conflict with their primary task. It is therefore necessary that independent regulatory bodies arise to supplement the regulatory role of central banks.

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The Impact of Sukuk investment in Developing UAE Economy1

By Dr. Abdussalam Ismail Onagun*

Abstract Purpose: Sukuk (Islamic bonds) is an integral part of Islamic economics and finance. It is an excellent source of funding for governments or companies who are craving for Shariah compliant tools which can foster the economic growth. The governments around the globe have taken deep interest in issuing and promoting Sukuk investment as the mainstream financial tools and the government of UAE particularly Dubai government has taken the lead in ensuring the Emirate being one of the first adapters of Sukuk in order to diversify its economy.

Design/methodology: A survey/interviews was conducted with Islamic banking professionals and investors The Data helped to examine the impact of Sukuk investment in diversifying UAE economy as the UAE possesses nearly 10 per cent of the world’s total reserves, and there is no doubt that oil will continue to provide the income for both economic growth and the expansion of social services for several more decades.

Findings:The Sukuk investment has always been preferred by the people who have preferences for the Islamic financial Systems. Thus it is imperative that the target market should be identified and the most attractive location has been identified as UAE as it has developed a strong market for Sukuk investment.

Originality/value: This research is to highlight the impact of Sukuk issued by Nasdaq Dubai on the UAE economy as one of the fastest growing financial products in Islamic Financial Institutions (IFIs). Finally, this research will analyze the potential of making Dubai as the centre of Islamic economics in

* Author: Dr. Abussalam Ismail Onagun is an Assistant Professor in the University of Modern

Sciences, College of Business. He has wide exposure in practical and academic research in Islamic Economic & Finance. Email: [email protected] / [email protected]

1 This paper has been presented in the international Conference on innovation Arabia 2015 organized by Hamdan bin Muhammad Smart University (HBMSU) Dubai, UAE.


line with the vision of Dubai government and foreseeable of economy growth opportunities in the Dubai Expo 2020.

Key words: Sukuk, UAE Economy, Financial Products, Economic Growth, Diversification and Securitization

Introduction This research paper aims to study the impact of the fastest growing product in

Islamic finance and its role in developing UAE economy. Sukuk (Islamic bond) is an alternative to interest bearing investment certificates or fixed income securities as it is Shariah compliance product. Sukuk offers investors a means of subscribing to certificates which give them a right to receive a share of profits generated by an underlying asset that is capable of being traded on the secondary market (Dubai International Financial Center, 2009).Due to this, Sukuk has become a very attractive product to sovereign and corporate issuers alike. They have used sukuk to get into a wider range of financing sources because of the increasing sophisticated financing and investment purposes. The usage of the word “sukuk” can also be traced back to the classical commercial Islamic literature. It was used to refer to the certificates for goods or groceries as the method of paying the salaries of government officers. These officers could later redeem such certificates according to their day to day consumption of goods or groceries.

In the wake of a rapidly growing Islamic economy, recent years have witnessed a surge in the issuance of Islamic capital market securities (Sukuk ) by corporate and public sector entities amid greater demand for alternative investments. As the Sukuk market continues to develop, new challenges and opportunities for debt managers arise as structured finance instruments are receiving increasing attention owing in large part to enabling capital market regulations and financial innovation aimed at establishing greater inclusiveness of Shariah compliance. These few lines will seek to explain and analyze definition of Sukuk development. The paper will analyse the NASDAQ Dubai Sukuk structure, and will provide the details steps of impact of Sukuk in developing UAE economy.

Definition of Sukuk Sukūk (plural of sakk), frequently referred to as “Islamic bonds”. It is an Arabic

word referred to as ‘certificates’, ‘Islamic bonds’ and ‘Islamic security’. But a more accurate translation of the Arabic word would be Islamic investment certificates. The distinction being that, at its simplest, a bond is a contractual debt obligation whereby the issuer is contractually obliged to pay to bond holders on certain dates. However, the process of pooling assets or issuance of the certificate is called (Taskik) Islamic Securitization. The Basel II defined securitization as “a structure with at least two different stratified risk positions or tranches that reflect different degrees of credit risk, where credit risk of an underlying pool of exposures is transferred in whole or in part”. It is also the process of gathering a group of debt obligations such as mortgages into a pool, and then dividing that pool into portions that can be sold as securities in the secondary market.

The Impact of Sukuk Investment in Developing UAE Economy


According to Suleiman (1998) securitization is the process of pooling assets, the process of packing them into securities, and the process of distributing securities to investors. As Islamic financial Institutions are more concerned with the Islamic acceptable of the securitization business, their focus is more on the content of the Sukuk or package rather than the process of packaging. Therefore, they tend to ensure that the assets in the package – and not the package alone are Shariah compliant.

The IFSB(2009) in its standard on Sukuk, defined Sukuk as certificates representing a proportional undivided ownership right in tangible assets, or a pool of predominantly tangible assets, or a business venture (such as a muḍārabah). These assets may be in a specific project or investment activity in accordance with Sharī`ah rules and principles.

However, Sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity. Zohra Jabeen defined Sukuk as asset-based investments where the returns come from the underlying assets. The underlying assets may be ijarah, Murabahah, Istisna’ or a combination of these.

From the above definition the standard makes it clear that Sukuk must be backed by assets that are subject to Shariah compliant contract; for example, an ijarah contract which is similar to a conventional lease. Furthermore, the standard makes it clear that the Sukuk documentation must demonstrate that any income arising must be derived from the underlying activities for which the funding has been used, and not simply comprise interest. The Sukuk must be backed by real underlying assets and these assets must be compatible with the Shariah principles. However, there must be full transparency as to rights and obligations of all parties.

It could be stated that securitization is the process of transforming an illiquid asset into a marketable security thereby rendering it liquid by the deployment or reaction of some market mechanism. Thus, borrowers in this way have access to the capital markets and lenders are able to liquidate their positions and opt for better investment opportunities.

It is important to clarify that, based on the definition of Basel II, there are great differences between the system of securitization in conventional financial institutions and Islamic financial institutions. For example, in the conventional system the tradable certificates or securities are issued out of interest-based loans in which case they are called promissory notes. Alternatively, they are issued for the raising of funds without any underlying facility or transaction in which is called bonds.

Difference between Sukuk and Bonds The principal difference between Sukuk and conventional securitization (bonds) is

that sukuk leads to the creation of Islamic Promissory Notes (IPN) or it requires the existence of an underlying financial asset. For example, Shariah encourages the documentation of contracts, after which these documents can play the role of securities and thereby become financial assets. Thus, a security cannot be considered as totally or


completely separable from the assets it represents which means that there is no Sukuk without first being a contract.

In this context, Sukuk certainly cannot be used as a means of raising funds simply with the issue of a document without any underlying assets, as it is in the conventional bonds issue. In the issuance of zero-coupon bonds, for example, the bonds are issued, under the system of Sukuk, prior to the receipt of proceeds, i.e., creation of debt. Furthermore, conventional investors in corporate and government bonds hope to capitalize on favourable developments in interest rates. Capital gains are accumulated when fixed-rate bond prices rise as variable market indices fall. The legitimacy of Sukuk structures in the Shari’ah lie in the fact that they do not take advantage of interest rate movements.

Investing in Sukuk issuances involves the funding of trade or production of tangible assets. Sukuk are directly linked with real sector activities. Hence these will not create short-term speculative movement of funds and potential financial crises. Sukuk investors have an inherent right to information on the use of their investments, nature of the underlying assets and other particulars that would otherwise be considered redundant in conventional investments. This will help introduce discipline in the market.

It appears from the above analysis that there are two major or principal criteria in the creation of Sukuk. First there must not be any interest rate attached to it, be it fixed interest or floating interest. Secondly, it must arise out of an underlying Islamic transaction. However, the following step will discuss some aspects of enhancing the competitiveness of Sukuk structures by overcoming some of the undesirable underlying risks. Therefore, we will like to explain Sukuk al-ijarah, its features and steps to be follow in the documentation of this Sukuk structure.

Parties in a Securitization Structure A key principle of Islamic finance is that financing schemes should be asset

backed. In the context of a Shariah-compliant securitization structure, this means that some degree of ownership in the underlying assets should be transferred to the Issuer (rather than a mere assignment of the cash flows). A transfer of absolute registered title in the underlying assets is not necessary and would prohibit securitizations of Middle Eastern assets as legislation in a number of Middle Eastern countries bars non-resident entities from purchasing or leasing certain locally domiciled assets and local entities from issuing debt securities.

Assets in Sukuk Securitization Assets in Sukuk structure must comply with Shariah, the assets being securitized

must themselves also comply with Shariah; that is, they must not offend the rules and principles of Shariah (such as being a securitization of pools of interest bearing loans, being uncertain in nature or being a securitization of prohibited items such as alcohol, pork, gambling or illicit activities). In addition, the relationship between an underlying obligor and the originator should fall within one of the accepted Islamic financing schemes e.g Murabahah, Mudarabah, Ijarah and Istisna'a. For example, when structuring a Shariah-compliant mortgage securitization, the underlying assets must be Shariah-compliant mortgages usually structured around Ijarah (the typical Islamic mortgage



structure) or Istisna'a (mortgages over properties that are being constructed). The Shariah requirement is that the assets back securitization must be linked to ownership of the Asset.

Transfer of rights in Sukuk The transfer to the issuer (from the originator) of a package of rights similar to

ownership that allows the issuer to participate in the revenues generated by the underlying assets and this is a general Shariah consensus that ownership of an asset is possible under a sale transaction. Most of the contemporary Shariah scholars in Islamic finance are satisfied that the risk and reward associated with the Sukuk assets is vested with the issuer of the Sukuk certificates. The Shariah scholars are also generally satisfied that the structure is in conformity with Shariah rules and principles. However, it is imperative that sufficient documentation is made to establish the actual transfer of ownership of asset. This principle has apparently been upheld in almost all the sale and lease-back sukuk structures so far executed. While appropriate purchase agreements were executed, the common practice has been to transfer only the beneficial title in the assets as opposed to actual legal title, but different sukuk structures raised different Shariah points of view regarding to risks and rewards of ownership of the assets based on the following:

• In Sukuk Ijarah, the owner of leasehold rights of an asset to be acquired and subject to lease contract may sell the usufruct of such an asset through sukuk issues (sukuk manfaa ijarah), and Sukuk owner wishing to undertake specific services may mobilize the cost of such services by pre-selling the services and their expected benefits through sukuk issued (sukuk milkiyat al-khidmat).

• The risks go to the originator in Sukuk al Ijarah based on their agreement in the beginning of the contract (‘Aqd). This is originated from the Shariah principle: al muslimun ala shurutihin (the Muslims are bound by their conditions). The same rule also applies to Sukuk al-salam, Sukuk al-istisna’a and Sukuk al-murabahah.

• But it is differed in Sukuk al mudarabah whereby the entrepreneur (mudarib) with a good business idea but without capital or little capital may mobilize sufficient fund for a proposed business/ project from capital providers through Sukuk issues (Sukuk al-mudaraba). The Sukuk holders share in the risks and rewards of the mudarabah.

• The same thing applies to Sukuk al musharakah. It is observed in sukuk musharakah where the owner of a business partnership may seek capital participations into the partnership through Sukuk issues (Sukuk al-musharaka). The sukuk holders share in the risks and rewards of the partnership.

• Shariah scholars have differing views on sukuk al wakalah which means that the capital may be raised through Sukuk issued to acquire certain assets or goods or services which are then entrusted to an agent (wakil) for


management of the same on behalf of the owners (sukuk al-wakala). The sukuk holders here take the risk of the underlying assets or goods or services and are entitled to any profits generated from the same.

• On the control of assets the contemporary Shariah scholars in Islamic finance unanimously agree that special purpose vehicle has the right to control and manage the assets or control of the assets

NASDAQ Dubai Sukuk Structure NASDAQ Dubai is the international financial exchange in the Middle East. It

allows companies to benefit from a unique investor pool that combines regional and international wealth, making it a globally unique platform for companies to raise money and for investors to find exciting opportunities. Dubai bridges the east and west and excels in areas such as trade, transport, tourism and real estate as well as financial services. In NASDAQ Dubai, it brings together the best of international standards with regional knowledge and understanding, supporting the growth of listed companies in the region and beyond.

The exchange’s broad investor base sets it apart from others. As well as investors in the UAE and the region, those in the US, Europe, Asia and elsewhere can easily trade its securities. This gives its listed companies instant recognition and visibility around the world, supported by the international NASDAQ brand name. Company owners have freedom to raise capital in the way that suits them. They can choose the price at which to sell shares in an IPO, and keep control of the company afterwards. Underpinning the exchange is a regulatory framework that is second to none, giving confidence to issuers and investors alike that their interests are being looked after.

As a leader in innovation, NASDAQ Dubai offers a wide product range. Companies can raise capital through shares, Sukuk and bonds. Exchange-traded funds, derivatives, exchange-traded commodities as well as Real Estate Investment Trusts (REITs) can be listed and traded too. NASDAQ Dubai is ideal for many types of companies, from family businesses to conglomerates, government entities and high growth businesses.

NASDAQ Dubai Sukuk al Ijarah Structure Most of the sukuk issuances in the UAE which have impact on its economy are

sukuk al ijarah, Sukuk al Musharakah and Sukuk Mudarabah. The lease or lease back agreement should be executed separately from the initial asset purchase agreement and according to Shariah the two should not be conditioned one upon the other. Any such conditionality of entering into the purchase of the assets so as to lease them back to the seller is not acceptable to the majority of Islamic jurists based on the hadith of the prophet “the prophet peace be upon him prohibited sale and (overriding) condition”. This equated to two agreements in one.

Sukuk al Ijarah is divided into purchase agreement, lease agreement, service agreement and purchase undertaking. This sukuk is based on property right to some other benefit based on the agreed price. Sukuk al Ijarah is generally issued on a sale and



leaseback arrangement of real estate. This type of sukuk is generally a popular structure with sovereign issuers. The proceeds from the sukuk are generally applied by the issuer to purchase real estate from the Originator and then the issuer leases it back to the originator. The Originator accepts to repurchase the real estate upon maturity or early settlement at the original purchase price. It is required by Shariah law for the issuer to undertake the major maintenance of the asset. However, most of the times an Obligor is appointed to take charge of those activities on behalf of the issuer(IFSB, 2009).The Sukuk issuance by the IDB, through NASDAC Dubai platform, serves as an excellent and promising example for future arrangements. The prospectus contained clear and precise Shari’ah considerations outlined by numerous leading scholars and it involved an innovative portfolio combination of Ijarah, Murabahah and Istisna projects (see figure 1). Also, returns were not ambiguously related to market benchmarks but were agreed upon a fixed rate of return on the relevant contracts and assets. However, some of the corporate and sovereign Sukuk prospectuses have come under increased scrutiny for their Shariah suitability. The predominant feature of several of the prospectuses is the floating rate return distributed to the Sukuk holders.

Figure 1 NASDAC Dubai Sukuk al-Ijarah structure (DIFC, 2010)

NASDAQ Dubai Sukuk Mudarabah Structure

This sukuk is divided into Mudarabah agreement and purchase undertaking. This is a cooperation agreement between the two parties; investors and managers of capital. This sukuk is an investment sukuk which denotes the common ownership of equally valued units in the Mudarabah equity. The holders of the Sukuk al Mudarabah are the suppliers of capital. They would own shares in the Mudarabah equity and its returns according to the percentage of ownership share (NASDAC Dubai 2011). The holders of Sukuk Mudarabah hold the right to transfer ownership by selling the deeds in the securities market.


Figure 2 NASDAQ Structure of Sukuk al- Mudarabah (DIFC, 2009)

NASDAQ Dubai Sukuk Musharakah Structure

This type of Sukuk is divided into Musharakah agreement, management agreement, and purchase undertaking. This usually involves two parties cooperating to install a capital for motivation. One of the structures that is popular among corporate issuers is Sukuk al-Musharakah. This was until the Accounting and Auditing Organization for Islamic Financial Institutions ruling on Sukuk at the beginning of the year 2008(NASDAC Dubai 2011). These rulings have prohibited the use of nominal value purchase undertakings in such sukuk. In Sukuk al-Musharakah, the subscription proceeds are contributed by the issuer to enter a joint venture with the Originator who contributes either his own capital/asset or makes a contribution of some type. The profits are shared between the Issuer and the Originator based on an agreement. However, Shariah requires that any losses should be shared between them according to the ratio of capital contributed (NASDAC Dubai 2011). See the figure below for more details.



Figure 3: NASDAQ Structure of Sukuk al- Musharakah (DIFC, 2009)

Impact of Sukuk in Developing UAE Economy

It has been estimated by Standard and Poor that 20 percent of investors who are willing to invest billions would now opt for an Islamic financial product spontaneously over a conventional financial product with similar risk-return profile. This means that there has been an increasing amount of use of the Sukuk. This is especially common in the United Arab Emirates and other GCC countries. In the year 2006, Sukuks worth $20 billion have hit the market. They were in varied structures and sizes. The companies have started to seek methods to diversify their sources of financing with Sukuk. Even though Sukuk have been actively used by companies in Kuwait, Bahrain, Saudi Arabia, and Qatar. Although in 2006, Malaysia has led the Sukuk issue market. NASDAQ Dubai had issue sukuk which has impact on the UAE economy. There have been a wide range of purposes for sukuk structures and they are evolving rapidly based on the needs and demands of issuers and investors.

They could be simple sale and leaseback structures like the $1 billion Dubai Department of Civil Aviation Sukuk which was issued in the year 2004, or it could be the $2.53 billion trust finance Sukuk structure issued by Aldar Properties in March 2007 which demonstrated the flexibility of Islamic finance principles (NASDAQ Dubai, 2014). Sukuk have been used to raise corporate finance for acquisitions or working capital purposes. There are several examples which show that Sukuk has evolved into a diversified, internationally acceptable instrument.

Due to the development of sukuk market, the UAE economy has transformed to become more diversified and is more driven by private sector. NASDAQ Dubai has used sukuk development to diversify the UAE economy in creating a platform for the global financial capital market with the hope to make UAE a center for Islamic economy. The presence of the deep and liquid sukuk market offers stability to the financial system in this highly competitive environment. It is also proven that sukuk can be implemented during the economic downturn. One of the examples for this was in 2005, the World


Bank has issued a Sukuk or Islamic bond for the redevelopment of Acheh after the tsunami of 2004 (ZetiAkhtar, 2010).

SukukNASDAQ Dubai and its impact on UAE Economy NASDAQ Dubai is a leading venue for the listing of Sukuk and bonds. Dubai being

the third largest Sukuk venue globally, it currently has a listing of a total nominal value of USD 24.05 billion. The exchange intends to expand its role as a global centre for Sukuk listings, in line with the Dubai government's intention to be the international centre of the Islamic economy. The following are the list of Sukuk issued by NASDAQ which helps the United Arab Emirates economy:

Table 1: List of sukuk in NASDAQ Dubai

List of Sukuk in NASDAQ Dubai 1. Al ShindaghaSukuk Limited (flydubai)

2. Alpha Star Holding Limited (DamacSukuk)

3. Dar Al-ArkanSukuk Company Ltd Trust Certificates 2016



6. DEWA Sukuk 2013 Limited

7. DIB Tier 1 Sukuk Ltd.

8. DIFC Sukuk Limited

9. DIP Sukuk Limited

10. DP World Sukuk Limited

11. EIB Sukuk Company Ltd Trust Certificates 2017

12. EIB Sukuk Company Ltd Trust Certificates 2018

13. Emaar Sukuk Limited Trust Certificates 2016

14. Emaar Sukuk Limited Trust Certificates 2019

15. EMG Sukuk Limited

16. GEMS MEA Sukuk Limited

17. Hong Kong Sukuk 2014 Ltd - 144 A

18. Hong Kong Sukuk 2014 Ltd - Reg S

19. ICD Sukuk Company Limited Trust Certificates 2020

20. IDB Trust Services Limited Trust Certificates 2015







25. IDB Trust Services Limited Trust Certificates Sept 2019

26. JAFZ Sukuk (2019) Limited

27. MAF Sukuk Ltd

28. Medjool Limited (Emirates Airline)

29. RAK Capital

30. Sharjah Sukuk Ltd

31. SIB Sukuk Company III Limited

Based on the list of Sukuk above, there is no doubt that Sukuk issue by NASDAQ Dubai has impact on UAE economy. A good example of this is the Dubai Islamic Bank. Dubai Islamic Bank issues Sukuk which is an Islamic bond; the Bank is a global leader in managing Sukuk that covers assets from aircraft to property. It uses many types of Sukuk that includes Murabahah, Istisna, Ijarah, Musharakah and Mudarabah (DIB, 2014).

The Sukuk Ijarah employed by the Bank is a lease contract between the Bank and the customer where the former is the lessor and the latter is the lessee. This contract is maintained for a certain period of time and the title of the property is transferred to the customer at the end of the period if the bank receives all payments properly. The period typically includes 3 to 7 years. Thus, the Bank helps its customers to lower their capital expenditure by acquiring the required machinery on leases instead of buying it. (DIB, 2014).

The Sukuk finance instruments of the Bank in 2013 are AED 2,807,603,000. The agreements are Shariah compliant. In 2008, one of the Bank’s subsidiaries issued a convertible Sukuk that meets the Shariah requirements by expecting a profit of 4.31% per annum. It was listed on NASDAQ Dubai which was completely redeemed in the month of January 2013. A non-convertible Sukuk also issued in 2008 in the form of Trust Certificates which were listed on NASDAQ Dubai which was completely redeemed in the month of July 2013. The profits that were identified on these Sukuk are expected to pay quarterly in arrears (Dubai Islamic Bank, 2013). In 2012, Trust Certificates were issued by the Bank by expecting 5.15% profit per annum. The profits that were identified on these Sukuk are expected to pay semi-annually in arrears. These were listed on Irish Stock Exchange that will mature in 2017. Dubai Islamic Bank issued Tier 1 Sukuk amounting to AED 3,673 million (DIB, 2013). Tier 1 Sukuk is a continuous security and does not have any fixed date for its redemption. Tier 1 Sukuk is listed on the Irish Stock Exchange and callable after the six years of period by the Bank in 2019. The net proceeds of the Bank are invested in the form of Mudarabah. The expected profit is 6.25% per annum and payable semi-annually (DIB, 2013).

Findings & Data analysis: Survey was conducted among a number of Sukuk investors' who already invest in

Islamic bonds in order to identify the opinions of the respondents and also studying the


relevant literature and phenomena. Below there are different bar-charts, pie-charts and Pareto diagram that illustrate Sukuk investors responses:

The following pie-charts show that more than half of respondents were Muslims, Educated people and male gender.

Sukuk demand is mostly driven by Shariah requirement

The survey results shows that 62% of investors invest in sukuk due to religious mandate to only invest in Islamic instruments; these investors are mainly Muslims. Diversification is the second primary reason for investing in sukuk; these are mainly by non-Muslims that are looking to diversify their investment portfolio given the attractive yields offered by sukuk.

UAE, Malaysia and Saudi Arabia are the top Sukuk investment locations for 2014

and 2015. There is a growing appetite towards the United States from investors and traders who may be looking to diversify their risk into developed economies. Investors show a preference for existing markets that are witnessing sharp Sukuk growth such as Turkey



UAE 25 Malaysia 18

Saudi Arabia 12

Qatar 9

Turkey 5

Bahrain 3

Singapore 3

United kingdom 1

United state 1

France 0

Investors and traders in UAE prefer to invest in sovereign issuances, then financial services, followed by Oil &Gas due to their solid credit and high cash inflow.

Sovereign 20

Financial Services 18

Oil & Gas 16

Power & Utilities 15

Construction 7

Real Estate 4

Services 5

Telecommunication 3

Transport 1

Most of arrangers agree that the cost of issuing sukuk is either the same or more expensive than conventional bonds.

Around 28 of investors believe that the liquidity and tradability drives the price gap

between Sukuk and bonds. The main reason behind the lack of liquidity and tradability is the relatively smaller size of the Sukuk market compared to bonds. In addition, there is


also the lack of shorter term Sukuk for treasuries to reinvest their short term deposits to meet their short term obligations.

Liquidity & Tradability 28

Sharia noncompliance risk

8

Sukuk paper scarcity 5

Sukuk structure 3

The majority of Sukuk investors' in UAE prefer shorter terms of 1 to 3 years.

Less than 1 year

1

1 - 3 years 26

3 - 5 years 8

5 - 10 years 1

10 - 20 years 1 20 years and above

0

Lead arrangers and investors agree that global market interest rates are the most important factor affecting sukuk pricing. Markets have been put under pressure by the U.S.



Global market interest rates

20

Investor business structure/diversity

3

Purpose of sukuk issuance

4

Size of sukuk 5

Sukuk rating 15

Type of currency 3

Type of issuer 3

Type of market (international or domestic)

5

Type of sukuk – assetbased or assetbacked

Sukuk pricing 4

Investors believe that the yield on Sukuk would rise more than 1% if there were a 1% rise in global interest rates.

Most of arrangers and investors believe that regional distribution in the sukuk

primary market affects Sukuk tradability and liquidity. 82% of investors say that distribution allocation in the primary market between the different types of investors (banks, government, funds. etc) affects tradability and liquidity.

Most of investors believe that the lack of global international Islamic banks with wide networks, such as HSBC, JP Morgan, and Citi Bank, is the most significant setback for sukuk tradability and liquidity.


It is noticeable that in all international and big sukuk issuance, conventional banks

are the main lead arrangers and book runners of sukuk while Islamic banks only play a secondary role by being a support to the issuance distribution limited to local markets.

Conclusion The Sukuk investment has always been preferred by the people who have

preferences for the Islamic financial systems. Thus it is imperative that the target market should be identified. The most attractive location has been identified as UAE as it has developed a strong market for Sukuk. The cost of issuing Sukuk is more or at least the same as the conventional bonds. This is affecting the success of sukuk as a whole. Sukuk is also facing tremendous issues in terms of marketability. It is being affected as the investors are not in a position to trade when compared to the conventional bonds.

The market for Sukuk is now maturing and there is an increasing momentum in the wake of interest from issuers and investors. Sukuk have confirmed their viability as an alternative means to mobilize medium to long-term investments from a huge investor base. Different Sukuk structures have been emerging over the years but most of the Sukuk issuance to date has been Sukuk al-Ijarah, since they are based on the undivided pro-rata ownership of the underlying leased asset, it is freely tradable at par, premium or discount. Tradability of the Sukuk in the secondary market makes them more attractive. Although less common than Sukuk al-Ijarah, other types of Sukuk are also playing significant role in emerging markets to help issuers and investors alike to participate in major projects, including airports, bridges, power plants etc.

This paper concluded that the sukuk issuance by NASDAQ Dubai has an impact on the UAE economy. This is as a result of the development of sukuk market, which has transform the UAE economy into a more diversify and driven by private sector. This in turn creates a platform for the global financial capital market in supporting initiatives by Dubai Government to make UAE a center for Islamic economy.

References Abdulkader T,& others,(2005).Structuring Islamic Finance Transactions, London:

Euromoney Books, p 154,

Sano, K. M,(2004).Sukuk al ijarah, a paper presented at the 15 meeting of Islamic Fiqh Academy Council, Sultanate of Oman, p 10-12.

Suleiman Abdi Dualeh,(1998). Islamic Securitization: Practical Aspects. A paper presented at the International World Conference on Islamic Banking, Geneva July 8-9, p2-3.

IFSB-7. (2009). Capital Adequacy Requirements for Sukuk, Securitization and Real estate investment, Malaysia: Kuala Lumpur, pp 3-4.

AAOIFI, (2003). Sharia Standards. Accounting and Auditing Organization for Islamic financial Institutions, Kingdom of Bahrain, p 298

Zohra J. (2006).Sukuk Structures – A Comparative Study from a Regulatory perspective, Islamic financial news, Vol 3, issue 18.



MonzerKahf, (1997).The use of Assets Sukuk al-Ijarah for bridging the Budget Gap, Islamic Economic Studies, vol4, pp 75-92.

http://www.nasdaqdubai.com/listing/listing-criteria#sukuk: Visited on 02 January, 2015

Sano, K.M,(2001). The Sale of debt as implemented by the Islamic Financial Institutions in Malaysia, Research Centre: IIUM press International Islamic University Malaysia, 1st ed, pp 20-25.

The council of Islamic Fiqh Academy, in its sixth session held in Jeddah, Kingdom of Saudi Arabia from 14-20 March 1990, resolved that Assets back securitization is permissible.

Sahih Bukhari

Ali A.T, (2004).Managing Financial Risks of Sukuk Structures, A dissertation submitted in partial fulfillment of the requirements for the degree of Masters of Science at Loughborough University, UK,.p 40.42.

Abozaid, A. and Al-JarhiMabid, (2010). Reasons for Failure of Some Sukuk Issuances. IRTI Islamic Economics Research Center Conference, King Abdul Aziz University, Saudi Arabia.

Afshar, T. A, (2013). Compare and Contrast Sukuk (Islamic Bonds) with Conventional Bonds, Are they Compatible? The Journal of Global Business Management, Vol9, (1), 44-52.

Ahmed, K, (2011). Sukuk: Definition, Structure and Accounting Issues. Visited November 2, 2014, http://mpra.ub.unimuenchen.de/33675/1/MPRA_paper_33675.pdf


Objectivising the Social Justice Paradigm in Islamic Finance: [An Appraisal]

By Abdul Azeez Maruf Olayemi,* Siti Mashitoh Mahamood,**

Marifatul Haq Yasini,*** Ahmad Hidayah Buang****

Abstract Islamic finance is hyposthasised as the avatar of egalitarianism, equity and the zenith of social justice. Nevertheless, some scholars argue that the social justice objective of the Islamic finance is idealistic. This paper examines the extent to which the acclaimed social justice objective is innate to the services of the institutions. The focal areas include the provision of benevolent loan, corporate social responsibility, the duty of the payment of Zakat, extermination of debt based instruments, total elimination of interest, gambling and uncertainty from the financial system. However, is it concluded that, although, Islamic finance strives to realize its social justice objective, nevertheless, the institution needs to lift the bar of its acclaimed financial egalitarianism further higher.

Keywords: Islamic Finance, Social Justice Introduction

The modern Islamic finance is projected as a financial system with the aim of realizing social justice, in variance with that of the conventional finance. The major end of the conventional finance is seen to be the maximization of the net income of its capitalist stakeholders. This objective of Islamic finance strengthens its appealing outlook across religions and regions. ‘Interest, gambling and uncertainty which are the underlying principles of the operations of the conventional system are eliminated from its

* Abdul AzeezMarufOlayemi, PhD, Post-Doctoral Research Fellow, Department of Shariah

and Law, API -IPPP, University of Malaya, Malaysia ** Siti Mashitoh Mahamood, PhD, Associate Professor, Department of Shariah and Law, API

/IPPP, University of Malaya, Malaysia. *** Marifatul Haq Yasini, M.Sc. Islamic Banking and Finance, International Centre for

Education in Islamic Finance (INCEIF), Kuala Lumpur, Malaysia. **** Ahmad HidayahBuang PhD, Professor, Department of Shariah and Law, API /IPPP,

University of Malaya, Malaysia.


practices. Its operations are structured on the mechanisms of sales, partnership or leases in order to guarantee its social justice objective in the financial system. This is, in addition to its promise of the assuaging of the conditions of the less privileged and the poor through the duty of payment of Zakat, provision of benevolent loan for business creation, corporate social responsibilities etc. Although, this is the light in which the modern Islamic financial system is projected, nevertheless, the aim has been reckoned as merely idealistic. This study surveyed some of the scholarly articles on the topic. The approach of the study is qualitative and narrative. It, thus, concluded that although there are a few misconceptions about the operations of Islamic finance, however, the criticisms are objectively constructive.

Importance of Social Justice in Islamic Finance To start with, the phenomenal disparity between the Islamic finance and the

conventional financial system is the emphasis of the former on the need for social justice in the financial system while the latter considers it as moralistic and unnecessary. Islamic finance operates on the principles that can ensure justice and equity in the distribution of wealth, opportunities, and privileges within a society through the financial system. However the conventional system is designed in such a manner in which, the capitalist stakeholders will move onwards to make more wealth through the financial system, while the working class and the less privileged will languish in economic demand. The operation of the conventional system on the basis of interest subjugates the larger world to eternal servitude to the very few capitalists. Therefore, the opening between the socioeconomic classes continue to expand, and there appear inequality in the attainment of education, wellness maintenance and living standards between the several economic strata. The modern Islamic financial system emerges as a universal remedy to the socioeconomic disparity. The operating mechanism of the Islamic finance, which is based on sale, partnership and lease is viewed as a promising method for the refurbishment of social justice if it is properly enforced. Nevertheless, the proper implementation of the mechanism by the players remains essentially questionable.

The review of the activities of the Islamic financial institutions shows that the institutions are yet to wholly uphold their acclaimed ethical identity (Hudaib, 2007). For instance, although, most of the Islamic financial institutions rely on common stock, which is considered acceptable under the Islamic law of transaction, given the inherent element of profit and risk sharing in it (Naughton, 2000). However, the trading of the stocks is still based on the conventional methods that include speculation which is considered as gambling and prohibited by the Islamic law of transaction. Other disputed practices in the system are the practices of short selling, margin trading, the use of stock index and equity futures and options which are purely conventional practices and are not compatible with the Islamic commercial law. Islamic finance needs to improve on these areas in its stock trading. Thus, the development of holistic Shariah compliant stock market is imperative for the industry to fulfil its social justice objective.

In the same vein, a survey that was conducted on the cost and profit efficiency of the Islamic financial institutions in some GCC countries shows that the efficiency of the institution is more centered to the generating of profits than the controlling of costs, which is an ethical matter (Mariani Abdul-Majid, 2010). This is the practice in the formal institutions that is thought immoral for Islamic finance. It will be erroneous for the


players of Islamic finance to believe that the institution can accomplish its social justice objective on that foundation. Such practice does not portray the institution positively in the area of its efficiency due to the gain in high loan activities (Abderrazek Srairi, 2010). Hence, since the founding stone of the practice of the Islamic financial institutions is the upholding of the Islamic ethic that is embodied in abstinence from interest based practise, uncertainty and gambling, there is a need for concerted efforts in the part of the participants to ensure that the principles are put into practice to attain the social justice objective.

In the other hand, only few Islamic financial institutions are complying with the requirement of the payment of Zakat which is meant to bridge the gap between the rich and the poor in the society. The commitment of the institution to the provision of benevolent loan and charity for the purpose of the microfinancing of the less privileged and for creating jobs is very slim. An investigation into the ethical identity index (EII) of seven Islamic financial institutions over the period of three years, in terms of microfinancing shows that only one of the institutions was above average. The remaining six institutions fall below average. This shows that the goal of the institution is to maximize profits, which is the same practice in the conventional financial institution.

Furthermore, Islamic finance has not reciprocated the patronage of the society, despite its social justice mantra. For example, the precept of corporate social responsibility is nonetheless to be adequately put into exercise by the institutions. The directors of the Islamic finance institutions need to shift their perception toward corporate social responsibility and fully stand by it to realize the social justice objective of the foundation. It is really clear that Islamic finance is lagging behind the conventional finance in this respect. A survey indicates that the contribution of the Islamic financial institutions to the creation of welfare through charity is really petite in comparison to the patronage it receives from the public (Thankom Arun, 2013).

Another affair that suggests the elusiveness of social justice in the practices of the modern Islamic finance is the reluctance of the institution toward creation of effective accessible platform for microfinance. The conventional microfinance is more accessible to the people round the world to a greater extent than the Islamic microfinance. This constitutes an impediment to the development of the Islamic institution at the grassroot level. A study of the condition of Islamic macrofinance in ten countries from the years 1996 to 2002 shows that Islamic finance needs to ameliorate its public acceptability through microfinance. Therefore, the objective of Islamic finance should not be just about profits. The social justice aspect should be brought to the forefront.

Additionally, since the debt based method of financing in the conventional system is considered as the obstacle to realization of social injustice in its practices, Islamic finance ought to wholly embrace the risk-sharing techniques rather than the risk-shifting methods in its practices to accomplish its social justice objective. The institution must completely refrain from the use of debt based instruments in its activities. Debt based instruments are the bane of all financial crises and social iniquity. In addition, there is a need for the creation of Shariah compliant pricing model for Islamic finance institution (Naifar, 2013).

Objectivising the Social Justice Paradigm in Islamic Finance……..


On the other hand, the above argument does not suggest that Islamic finance has completely abandoned its social justice objective. The criticism is meant for the spuring of the institution to progress on its obligation toward the society. Islamic finance has contributed significantly toward the realization of the social justice objective in some jurisdictions. For example, a survey of the ethical practices of the Bangladeshi Islamic financial institutions between 1983 and 2010 shows that there is improvement in its relationship with the society, due to the advance in its sustainable development programme, charity and employee wellbeing. The improvement is attributed to the acceptance of the method of wider stakeholders’ approach in the services Islamic finance in the rural area. Therefore, the bank adjusted from the pattern of dependence on debt-based method for the management of their investment portfolio to the method of socioeconomic development which is the mission of the Islamic finance in the society (Ataur Rahman Belal, ‘n.d.’).

Another good example in this context is that of the Islamic finance in Malaysia. The Malaysian Islamic financial institutions diverted a favourable output of its financial market toward the funding of projects which in turn contributed to the creation of businesses, in fulfilment of the social justice objective. Thus, the public participation in the macroeconomic augments and the financial stability became formidable. That is due to the development of Islamic financial institutions in the country, as a result of the obligation to the execution of the social justice objective through Islamic microfinance (Ibrahim, 2007).

Toward the Social Justice Objective Last of all, as Islamic finance is becoming increasingly acceptable across the

western oriented societies, in Africa, Asia, Europe and etc. The institution needs to shore up the acceptability with a dynamic implementation of the social justice objective to establish its uniqueness, and dissimilarity to the prevalent capitalist conventional finance. One of the major issues hitherto was the challenge of the acceptability of the institution in the western oriented world. Nevertheless, the opponents of Islamic finance in the jurisdictions have now come to terms with the reality that the principle of prohibition of interest and usurious practices, upon which Islamic finance operates, is actually in conformity with the financial doctrine of all the three Abrahamic religions of Judaism, Christianity and Islam (Foucart, 2013). This perception gives the Islamic finance a supplementing opportunity of acceptability in the Christian western world.

Moreover, although, there appears to be a slight disparity between the concepts of usury and interest in the Christian faith, (Abraham, 2007), that is to say that, while Christianity forbids usury for the reason of being an excessive increase on actual loan and disruption of equity between the loan provider and the beneficiary, it does not forbid interest. The faith permits interest on the basis of its interpretation as a mere compensation to a loan provider. Conversely, the Islamic financial law does not differentiate between interest and usury. Both are considered as the prohibited ‘riba’ which is an increase on a loan or debt. Nonetheless, the slight difference in the interpretation is no more than elucidation. The reality is that all the religions do not accept usurious practices. This aids the perception of the western oriented societies to change positively toward Islamic finance. For that reason, the positive perception ought


to be complemented with the social justice objective to speed the development of the institution in the jurisdictions.

Thus, it can be reasoned that the development of Islamic finance currently rests on its dedication to the pastime of its social justice objective as contrary to the line of reasoning that the Shariah requirement policy is an obstruction to its growth (Zarrokh, 2009). The main obstacle to its growth is its ineptitudeness toward the realization of its social justice objective. In fact, Islamic finance is being perceived as a parallel financial system to the conventional system in the setting of worldwide business operations (Foucart, Western Financial Agents, and Islamic Ethics, 2013). It has come out as an alternative to the conventional capitalist system. The western financial managers have jettisoned the negative prejudices (Rice, 1999). Thus, it is up to the system to maintain itself as a viable alternative by catering for the needs of the less privilege and those at the grassroots through a vigorous pursuit of the social justice objective of the scheme.

Conclusion To sum up, it can be deduced from the available literatures that Islamic finance is

far from carrying out its social justice objective. There is a need of the institution to recommit itself to its acclaimed ethical identity to achieve the social justice objective. Therefore, with the positive perception and the acceptability that the Islamic finance is garnering across the world, having proved itself as a buffer against any financial crisis, the institution needs to improve in the contentious areas in its practices. One of such areas is that of the its equity market. Although common stock is supposed to be acceptable to the Islamic commercial law, nevertheless, matters of speculation, short and margin trading, the use of line index, equity futures etc. are however questionable. The deficiency of difference between Islamic and conventional stock markets does not portray the Shariah compliant stock market in the light of pursuing its social justice objective. The realisation of the social justice objective of the Islamic finance takes a breather on the total compliance of the establishment with the ethical demands of the Islamic commercial law. The requirements are embodied in the elimination of usury or interest (riba), gambling or speculation (Maysar) and uncertainty or speculation (ghara) from the financial system in totality. Additionally, Islamic finance needs to recommit itself to the obligations of payment of Zakat, provision of benevolent loan, socioeconomic development and corporate social responsibility (CSR). This is the only approach in which the social justice objective of the Islamic finance can be realized.

Bibliography AbderrazekSrairi, S. (2010). Cost and profit efficiency of conventional and Islamic banks

in GCC countries. Journal of Productivity Analysis (34:45–62), 1.

Abraham, C. J. (2007). Usury and Just Compensation: Religious and Financial Ethics in Historical Perspective. Journal of Business Ethics (72:1–15), 2.

Ataur Rahman Belal, O. A. (n.d.). Ethical Reporting in Islami Bank Bangladesh Limited (1983–2010). Journal Bus Ethics , 3.

Foucart, E. S. (2013, February 28). Western Financial Agents and Islamic Ethics. Journal Bus Ethics , 5.

Objectivising the Social Justice Paradigm in Islamic Finance……..


Hudaib, R. H. (2007). Roszaini HanifExploring the Ethical Identity of Islamic Banks via Communication in Annual Reports. Journal of Business Ethics , 3.

Ibrahim, M. H. (2007). The role of the financial sector in economic development: the Malaysian case. International Review of Economics , 54 (4), 14.

Mariani Abdul-Majid, D. S. (2010). Efficiency in Islamic and conventional banking: an international Comparison. Journal of Productivity Analysis , 2.

Naifar, M. A.-S. (2013, September 10). Islamic Corporate Governance: Risk-Sharing and Islamic Preferred Shares. Journal of Business Ethics , 3.

Naughton, S. N. (2000). Religion, Ethics and Stock Trading: The Case of an Islamic Equities Market. Journal of Business Ethics ( 23: 145–159), 3.

Rice, G. (1999). Islamic Ethics and the Implications for Business2. Journal of Business Ethics (18: 345–358), 2.

ThankomArun, Z. A. (2013). Corporate Social Responsibility and Islamic Financial Institutions (IFIs): Management Perceptions from IFIs in Bahrain. Jounal of Business Ethics , 3.

Zarrokh, E. (2010). Iranian Islamic banking. European Journal of Law and Economics , 5.


Crowdfunding and the Opportunity Presented in the American Islamic Financial

Sphere By

Husam Suleiman∗

Abstract This paper serves to explore the next paradigm of evolution regarding Islamic finance products in light of the development and vast success of crowdfunding platforms1. The first section examines the shifting paradigm of the Islamic finance lending product in America; the Islamic finance mortgage product. Demonstrated is that each subsequent shift in lending procedure has removed Islamic attributes associated therein, resulting with current products that have lost the substance of Islamic teachings and have fundamentally converged to the conventional product in function and form. The second section then reviews the methodology and practice of crowdfunding in the current financial landscape. Thereupon, juxtaposed are the advantages and attributes of crowdfunding and Islamic finance, highlighting the overwhelming similarities. The third section accordingly considers the current opportunity presented with crowdfunding, outlining additional attributes that must be present in an Islamic finance product. The article ultimately concludes by calling upon Islamic financial product developers to explore and pursue the current opportunity presented by the natural pairing of crowdfunding and Islamic finance products.

Keywords: Crowdfunding, Alternative Finance, Cooperative Finance, Islamic Finance

1. Introduction Critical examination of the paradigmatic history of the American Islamic mortgage

Islam is a complete and integrated code of life encompassing all the affairs and

∗ Author: Inland Empire Zakat Cooperative, 11478 Southampton Court, Rancho Cucamonga,

CA 91730, United States of America, 01 818 522 7266, [email protected] 1 Although this paper aims solely to discuss the American Islamic Mortgage, the relevancies

can easily be extrapolated to other segments of finance.


interactions between individual and society, manifesting itself, in the communal aspect, as justice, brotherhood, and social welfare.

Narrowing the focus, Islamic finance aspires to create the conditions which maximize the success of the individual, and society, by the incorporation of ethical values; such as justice, benevolence, moderation, sacrifice, consideration, and cooperation2. The Islamic approach to charitable givings, cooperative business agreements and the mandating of disclosure exemplifies the application of such attributes.

Conversely, dealings [and contracts] that exploit, deceive, hoard resources or guaranteed gain without liability are Islamically unlawful.

In the dominant method of Islamic finance demonstrated in America, the Islamic finance mortgage product, there has been a steady regression towards the conventional counterparts.

A brief summary will show that the early methods of finance implemented were highly altruistic, cooperative and conforming to the character of Islamic finance. The subsequent shifts slowly removed attributes of Islamic finance and introduced prohibited items into the transaction. Ultimately, the current products resemble, in form and function, that of the conventional product, ladden with prohibited issues and not consistent with the spirit of Islamic finance.

The shifting of the Islamic finance paradigm has seen several definitive stages.

1.1 Immigrant Lending Model Immigration of Muslims to America increased rapidly following the adoption of the

Immigration and Nationality Act of 1965 [Hart-Cellar Act]3.

Having no established credit or employment, obtaining financing using traditional methods would prove to be difficult for newly immigrated Muslim. As a result, to facilitate financing, immigrants would simply borrow from family and friends [often referred to as intra-family loan/mortgage]. Intra-family lending was not inordinately novel as it was a prevalent method of finance in the respective home countries of the immigrants. Such loans enabled immigrants to purchase businesses and homes in lieu of traditional bank financing. The terms of lending were typically very short and interest was low, or for the Islamically inclined, not present. This method encapsulates the crux of Islamic Finance, as described above by Chaudhry.

The benefits of such intra-family lending were considerable for borrower as the process was relatively straightforward and did not consider typical bank requirements such as credit scores and debt to value ratios. Underwriting consisted of the assessment of character [status], relative financial aptitude, and relevant payment history of the borrower. If the loan pertained to a business, assessment of the feasibility was conducted by the lender, as both parties shared a vested interested in the entrepreneur's success. 2 Chaudhry, Muhammad Sharif. "Fundamentals of Islamic economic system."Burhan

Education and Welfare Trust 198 (1999). 3 Arab Americans an integral part of American society. Dearborn: Arab American National

Museum, 2010. Print.


Simply written contracts were utilized, if any, which contained no ambiguity. Unsecured by nature, recourse methods would be limited to social pressure by family to influence repayment.

The degree of success of obtaining finance ultimately depended upon the network [family and friends] of the borrower. The proximity of new immigrants, geographically and ideologically, helped facilitate cooperation and support. However, the foundation of intra-family lending revolved around the beneficent nature of the lender, as well as a desire for the success of their fellow compatriot.

Although not as commonplace as the past, Americans continue to utilize intra-family lending as a method of finance4.

1.2 Community Bank Loans / Relationship Banking As immigrants settled and assimilated, they established accounts and relationships

with [Thrift and Community] banks. Banks originated Interest bearing [commercial, industrial and consumer] loans based on the private information gathered through such long-term relationships. These loans were often intermediary and collateralized. Banks usually did not face much competition in making such loans, which kept the interest rates relatively high5.

This shift in financing not only introduced interest but other factors associated with borrowing funds, such as excess leverage, an increase of spending and a reduction of savings31.

Permissibility out of necessity (Ruling of the Fiqh Council of North America)

The ensuing shift came about as immigrants built up suitable credit, commercial lending intermediation declined in favor of conventional real estate loans, which offered more favorable rates, longer terms and higher LTV’s. This trend continues to this day as the percentage of commercial and consumer loans continue to decrease while real estate loans increase6.

Subsequently, Muslims [conscious of interest] sought clarification from scholars regarding the permissibility of conventional mortgages.

As a direct result, in late 1999, the Concluding Declaration of the First Fiqh Conference of the Fiqh Council affiliated to the League of Shari’ah Scholars of North America stated that, ‘where a Shari’ah compliant alternative is not available, and a Muslim wants to own a house, via a bank mortgage, most of the participants take the view that it is allowed to own the house via a mortgage from the bank, due to the need, which is treated as a necessity7.’

4 2013 Survey of Consumer Finance Chartbook, Board of Governors of the Federal Reserve

System, Washington. 2013. ‘ Other’ lending amounts to over 6%, part of which would constitute loans between friends

and family 5 Hubbard, R. Glenn, and Anthony Patrick O'Brien. "Money, banking, and the financial

system Pearson." (2012)., p. 286 6 Reserve, Federal. "FEDERAL RESERVE statistical release." (2010). 7 Al-Sawi, Dr Salah, ‘A Polite reconsideration of the fatwa permitting interest-based

mortgages for buying homes in Western societies,’ 2001

Crowdfunding and the Opportunity Presented in the American……


The council acknowledged the prohibition of interest; however, based on necessity, most participants permitted the adoption of a conventional mortgage. Further recommended was that effort continue to create Islamically acceptable alternatives and to support and strengthen Islamic groups, banks, and organizations working to do so8.

The opinion of the council did not convince the staunch opponents of interest. As a result, individuals who did not feel comfortable with the ruling continued to avoid conventional mortgages. Those who felt comfortable, or indifferent, generally obtained a conventional mortgage with the associated attributes.

1.4 Islamic Contracts Following the recommendation of the First Fiqh Conference, the next phase of

evolution focused on the methodology of the loan. The formation of Islamically ‘compliant’ method, based on contracts, followed. Most common were forms of ijara (lease to purchase), Murabaha (cost-plus sale) and Musharakah (partnership). Such contracts existed elsewhere before gaining traction in the US [such as Al-Baraka Bank in London] after notable scholars, such as Qaradawi, issued rulings in favor of the mechanism implemented9.

The pioneers were financial intermediaries. Funds borrowed would correspond directly with the amount of capital [deposits in forms as profit sharing accounts] raised and obtained from investors. The Islamic banks would then purchase real estate with the homebuyer, based on the acceptable methodology, in which there was no mention of interest10.

The amount of loans written were directly correlated to the finite working capital. As a result, a severe bottleneck developed as the products gained more popularity. Further detrimental was that the cost of obtaining Islamic contract mortgages was greater; as additional administrative costs encircled the Islamic contract. The contracts also required a higher down payment versus conventional loans. Consequently, scholars [circa 2001] issued opinions permitting conventional versus Islamic financing as ‘reasonable’ alternatives were not available; if Islamic mortgage were unattainable for a potential homeowner, or the Islamic finance providers were so few that dealing with them would be more risky, it would be permissible for the Muslim consumer to utilize conventional finance11.

8“ To work to provide Islamic alternatives to solve the problem of financing residences by

creating a sufficient number of Islamic financial institutions or co-operative housing associations (which it is hoped will consider the circumstances and needs of those with limited income), in order to move from the situation of concessions and necessity to one of determination and choice.”

9 ElGamal, Mahmoud (1990) Translation of Selected Fatwa of Al-Baraka Seminars - Seminar 6 [text]. Retrieved from http://www.lariba.com/fatwas/qaradawi.htm

10 Zyp, Victoria Lynn. Islamic finance in the United States: Product development and regulatory adoption. Diss. Georgetown University, 2009.

11 Delorenzo, Yusuf Talal. "Mortgages for a Home." Http://muslim-investor.com/answers/mortgage-for-a-home.html. Muslim-Investor, 13 Mar. 2001. Web. 23 Feb. 2016. <http%3A%2F%2Fmuslim-investor.com%2Fanswers%2Fmortgage-for-a-home.html>.


Although mortgages took a clear step in the Islamic direction [via acceptable

contracts and intermediation], limiting factors, such as capital and higher cost, made it difficult to increase market share.

1.5 Securitization of Islamic Mortgages The most recent shift of the lending paradigm took place in order to resolve the

capital influx conundrum. Strategic alliances developed with Government-Sponsored Enterprises [GSE’s]. Subsequently, this translated to unlimited funds, lower costs, and larger product selection for the providers of Islamic mortgages when securitized in the secondary market.

Following the GSE alliance, LaRiba, a pioneer of the contract method, expanded its market share from 2-3 homes per month to more than 50 per month! In addition, the product base also expanded to include lower down payment options. Meanwhile, companies that evaded the secondary market affiliations retained a limited market share. Ameen Housing, a successful mortgage co-operative, can only support approximately 20 homes per year due to the dependence on deposits.

The increase in market share, for Islamic providers, came at a cost of sharp criticism as the product highly resembled the conventional market alternatives12. As the method of affiliation with the GSE’s became better understood, scholars reconsidered the involvements of the GSE’s and advised borrowers to find an alternative. This view became more mainstream following the release of the opinion of the Assembly of Muslim Jurists of America [AMJA] in October of 201413.

The AMJA opinion [regarding all current mortgages involved with the GSE’s] is quite clear; to fully avoid the contracts as they do not differ from the conventional contracts, or to use said contracts in the presence of need [as there are contractual deficiencies]. The one provider that did receive a favorable rating, Ameen Housing, does not involve itself with the GSE’s. However the adherence to the standard conventional benchmarks [not addressed in the AMJA opinion], and subsequent negative attributes, should be noted32.

Even prior to the AMJA opinion, the American Muslim masses had yet to endorse Islamic Mortgages. A survey by HBSC [2002] showed that less than 10% of US Muslims used Islamic based services; and only 4% had Islamic mortgages - while 64% identified as not having Islamic mortgages. Mahmoud El-Gamal, chair professor of Islamic economics at Rice University in Houston, commented, "I will be among the first to admit that the terms 'Islamic banking' or 'Islamic finance' can be quite misleading, given the many similarities between Islamic and conventional financial contract14."

The net effect of the respective paradigm shifts of the lending model is that from one of an altruistic nature to that of the convention. The next phase of evolution of the

12 Abdul-Rahman, Yahia. The Art of RF (Riba-Free) Islamic Banking and Finance: Tools and

Techniques for Community-Based Banking. John Wiley & Sons, 2014.(198) 13 AMJA Resident Fatwa Committee resolution about Islamic Home Financing Companies in the

US, Oct 14, 2014. 14 Malik, Naureen S. "Interest-Free Financing for U.S. Muslims." ABC News. ABC News Network,

1 July 2002. Web. 12 Sep. 2015.



Islamic lending model must focus on evolving Islamic finance out of the futile exercise of developing products that remove interest from the primary transaction, and into one that aims for the instituting of Islamic ideals into the fabric of the product. A trend developing in the financial sphere could pose a significant opportunity for product developers to create the next paradigm Islamic lending.

2. The Crowdfunding Effect on the Current American Finance Landscape Often attributed as a recent phenomenon, the ‘sharing economy’ [sharing economy

is the larger concept involving resources, vs. crowdfunding; a subset which specifically deals with funding] is a methodology built around the sharing of resources. Such sharing can take place in the form of renting, shared ownership, exchanging and trading with the emphasis on sharing of physical, human and economic resources15.

The utilization of this methodology promoted the building of one of America’s greatest icons; the Statue of Liberty. In 1885, Joseph Pulitzer raised over $100,000, for the pedestal of the icon, from over 125,000 people by public plea through his newspaper; ‘New York World.’ This enormous amount of money [over $2M equivalency today] raised remained the largest amount crowdfunded for nearly 130 years16.

In recent financial terminology, crowdfunding methodology developed into an organized industry in the mid 2000’s. Leveraged by a technology platform facilitated through the internet, borrowers could now connect directly with lenders to finance in aggregate from individual lender funds as modest as $5.. Banking intermediaries could now be eliminated as borrowers connected directly with lenders at agreed upon terms. Ultimately, borrowers were provided with an alternative to commercial bank financing.

The sharing economy methodology possesses attributes that are fully in line with Islamic concepts and ultimately Islamic business and social principles. Such interlinked attributes can be summarized as follows:

1. Cooperation. Fundamental to the sharing economy is the collaboration and participation of individuals with identified resources. The syncing, sharing and distribution of the respective resources and assets, benefit both parties. The fostering of such mutual cooperation is the nature of Islamic teaching and business practice. Conversely, there is a stern warning relayed, in the Quran, to one who chooses not to promote mutual cooperation; It is He who made you the vicegerents of the earth and raised some of you in ranks over others so that He may test you in what He has given you. Surely, your Lord is swift in punishing, and surely He is Most-Forgiving, Very-Merciful [6:185].

2. Consultation. A benefit of mutual cooperation and active involvement is the support and assistance of others. Such vested interest transpires with the

15 Sundararajan, Arun. "Peer-to-peer businesses and the sharing (collaborative) economy:

Overview, economic effects and regulatory issues." Written testimony for the hearing titled The Power of Connection: Peer to Peer Businesses, January (2014).

16 Dehner, Joseph J., and Jin Kong. "Equity-Based Crowdfunding outside the USA." U. Cin. L. Rev. 83 (2014): 413.


consultation of others who may possess an innate ability required for the success of an endeavor. Accordingly, the contribution of the business and intellectual resource is an attribute of those who believe and place their trust in Allah17.

3. Altruism [benevolence]. An additional benefit of mutual cooperation in the sharing economy is the endorsing of an altruistic culture. Such altruism is the ‘Golden Rule’ shared by Muslims18 as well as many faiths and philosophies19. An added benefit of said altruism is multiple health benefits and happiness20.

4. Individual Empowerment. The culmination of cooperation, consultation and altruism lead to individual empowerment towards striving for success and self-actualization. The fulfillment of self-actualization is incumbent upon individuals in order to reach their given potential. This concept is consistent with Islam, and other religions, as man is a vicegerent on the Earth21. Said fulfillment of this responsibility requires individuals to reach their given potential.

5. Spawning Enterprise. Moving beyond individual development, the sharing economy affects the much larger community. Small businesses are key players in regional and national economies as they generate employment, increase tax revenue, raise the standard of local living and fostering innovation. They also counter the effects of monopolistic enterprises by offering higher quality, greater efficiency, and improved customer service. Along with the economic benefits, the creation of business, via cooperation and consultation, establishes an alternative to interest; as exhibited by the final stage of the ban on interest 32.

6. Circulation of Wealth. Circulating wealth, and expanding said circulation, increases the health of an economy, improves the life of the citizens and invigorates the economy22. This hedge against hoarding transforms idle resource into a usable resource, which is a concept that is the crux of Islamic financial teachings23.

7. Bank Detachment. Crowdfunding, coupled with technology, has removed corporate banks, and the respective negative attributes, from the lending equation

17 And those who have responded to their Lord (in submission to Him), and have established

Salah, and whose affairs are (settled) with mutual consultation between them, and who spend out of what We have given to them, (42:38)

18“ None of you truly believes until he loves for his brother what he loves for himself.” (Saheeh Al-Bukhari)

19 Antony, Flew. "A Dictionary of Philosophy." Pan Books in association with The MacMillan Press.(1979) p. 134.

20 Post, Stephen, and Jill Neimark. Why good things happen to good people: How to live a longer, healthier, happier life by the simple act of giving. Harmony Books, 2008.

21 Ozsoy, Zekeriya. "A True Understanding of Self for Self-Actualization." (2010) The Fountain Magazine, Issue 74, March - April 2010.

22 Wen, Yi & Arias, Maria A, “What does money velocity tell us about low inflation in the U.S.” Federal Reserve Bank of St. Louis (2014)

23 Ahmad Asad Ibrahim , Radwan Jamal Elatrash , Mohammad Omar Farooq , (2014) "Hoarding versus circulation of wealth from the perspective of maqasid al-Shari'ah", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 7 Iss: 1, pp.6 - 21



by unifying the lender and creditor directly. The removal of intermediaries has increased efficiency and reduce the cost by 60%24.

Currently, there are several models of crowdfunding in the financial sphere; the reward, lending, and equity models25. All models require the entrepreneur [seeker of funds] to create a profile on the respective technology platform. The profile introduces and outlines the purpose of the request, e.g., production of a product, social cause or activity. Included in the profile would be any relevant business documents; business plan, background information, and industry experience. Lenders consequently browse the listing on the respective technology platforms and select ventures to engage with.

2.1 Reward Model26 In this model, the entrepreneur sets a target amount and duration for the solicitation

of funds. Donors commit to a monetary contribution in the form of a grant, pre-purchase or in lieu of a reward. The grant variation is an unadulterated gift. The pre-purchase variation is simply a pre-purchase of the product upon successful completion. The reward variations offer rewards such as intangible items [early access to an event] but often include the item being produced, and/or a discount on the product. Contributors do not receive any financial return or equity in the venture. Typically the facilitator charges a fee ranging from 3-5%. Kickstarter.com and IndieGoGo.com are successful examples of this model type.

2.2 Lending Model There are two variations of this model; interest and non-interest based.

With the Interest Based model [often referred to as peer to peer lending; p2p], the technology provider [intermediary/originator] assesses the financial feasibility of the entrepreneur/borrower and subsequently adjust the interest rate in accordance with risk. Investors purchase segments of the respective loan with the anticipated rate of return, and can diversify their investments by purchasing a wide array of loans across different investment grades, in amounts as low as $25. Loans typically range from $500 to $35,000. Loans created are unsecured [personal loans with no collateral] with little or no recourse [recourse does exist with civil enforcement methods, however is circumventable by the proper council]. The originator charges a fee for formation and service; underwriting [3-5%] and servicing [1%]. Pioneers in this model are such sites as LendingClub.com and Prosper.com whose largest segment are loans consolidating debt.

Non-Interest Based Models operate similarly, however, are limited to socially beneficial and/or responsible ventures. Dollar ranges are lower and origination expenses are often offset by the lender or donations. Similar to the Reward Model, loans are unsecured and lenders do not receive any financial return or equity, and in this case, no interest, of the venture. Kiva.org fits in the non-interest model, however, they consolidate investor funds and lend them to microfinance ventures which extend interest bearing loans to individuals. 24 Leech, Cormac, et al. “P2P Lending: Opportunity & how to invest.” Liberum Capital

Limited (2014) 25Bannerman, Sara. "Crowdfunding culture." Wi Journal of Mobile Media 7.1 (2013). 26Donation, reward & pre-purchase models are often separated, however grouped here together for simplicity


2.3 Equity Model

Small business and start-ups solicit funds from investors in the form of an equity stake [it could also be straight debt, a convertible note or revenue sharing] in the venture. This model is regulated under securities laws if the dollar amount exceeds a certain threshold27. Similar to the other models, the technology provider charges a percentage upon successful funding. Sites of this model type are Crowdfunder.com and EquityNet.com.

With the exception of interest in the lending model, all the characteristics demonstrated ultimately highlight the beneficial and humanistic properties of lending. There has yet to be a mainstream lending platform with Islamic ideals, and specifically an option, albeit Islamic or not, to challenge the current conventional mortgage paradigm.

3. The Opportunity The [American] borrower and lender have embraced the above crowdfunding

models and methodology as evident by the numbers; 2014 crowdfunding totals nearly $9.5B in America [over $16.2 globally], with business and entrepreneurship claiming 65% and social causes at 32%. Total estimated figures for 2015 are over $34B28increasing at a steady compound annual growth rate [CAGR] of over 130%29.

The pairing of Islamic finance and crowdfunding could quite possibly evolve the current American Islamic mortgage product from that whose emphasis is almost entirely focused on interest aversion into a product that embraces Islamic fundamentals. Such an Islamic finance product, consistent with the sharing economy methodology, could conform with ALL Islamic financial teachings; versus focusing on a few. The encapsulating of the entirety is reflective of the command, “Oh you who believe, enter into Islam in its entirety [completely and perfectly]30.

In addition to the characteristics currently demonstrated with crowdfunding, an Islamic mortgage option should conceptually also manifest the following attributes;

1. Remove all traces of interest, or rate of return, if collateralized. The current Islamic mortgage paradigm of loan collateralization, which guarantees the bank in the event of a default, while making a profit [as a business partner], violates the essence of the Islamic legal maxim of profit and risk sharing; Al-Ghunmu bil Ghurmi - Entitlement to profit with accompanying risk31.

2. Dissuade the culture of debt. Contentment and moderation are analogous with an Islamic lifestyle. In lieu of such moderation, the cultivation of charitable spending becomes difficult. Education is the key to counter the conceptions of consumerism and the culture of borrowing that constitute the backbone of capitalism. Islam

27 Bradford, C. Steven. "Crowdfunding and the federal securities laws."Columbia Business

Law Review 2012.1 (2012). 28 “2015CF Crowdfunding Industry Report.” Massolution, (2015) 29 Moldow, Charles, (2014) “A trillion dollar market by the people, for the people”,

Foundation Capital 30 Quran 2:208 31. Ayub, Muhammad, “Understanding Islamic Finance.” John Wiley & Sons (2009) p. 81



engages in moral education and training in order to create a spirit of cooperation, mutual love, and self-help among its followers.

3. Short-term. Consistent with the above aspiration, the short-term concept is nothing new to Americans, as short-term loans were the norm prior to the formation of the GSE’s. An additional attribute of the short-term model was that the borrower typically needed a sizable down payment, which was indicative of lower default rates.

4. Remove all traces of ambiguity and deception. Current bank financing agreements can be in excess of ten pages. As a result, banks have capitalized on the opportunity to bury details and practices that are deceptive and illegal, and as a result have faced billion dollar settlements32.

5. Not necessarily competitive. Competitive products pose an interesting dilemma; How can you compete with a product that incorporates Islamically forbidden elements? More importantly, should you attempt to compete with such a product? Consumers who are in search of more money to borrow will base their product choice on ease of access and amount of funds. As a result, Muslims have obtained conventional financing ‘against their will.’33When presented with an Islamic option, not all consumers would opt for it due to the ease of access of the convention34. The current driving factor behind product development has shifted towards capitalization of market share in lieu of the development of an organic Islamic product. The result of the market share increase comes at the expense of regressing toward the conventional counterpart, as noted in the prior section. Correspondingly, the detrimental effects of the conventional products ensue35.

Notwithstanding the hindrances of changing an industry fully entrenched in the American society, Islamic influence will continue to impact the financial sector. However, the design of influence is slow implementation coinciding with education36.

Such large paradigmatic shifts may seem daunting, nonetheless, they have historically taken place in the American financial sector; the establishment of Credit

32 `Barnett, Harold C., And Some with a Fountain Pen: Mortgage Fraud, Securitization and the

Subprime Bubble (November 19, 2010). HOW THEY GOT AWAY WITH IT: WHITE-COLLAR CRIME AND THE FINANCIAL MELTDOWN, Columbia University Press, Forthcoming.

33 Abdul-Rahman, Yahia K., and Abdullah S. Tug. "Towards a LARIBA (Islamic) Mortgage Financing in the United States Providing an Alternative to Traditional Mortgages." International Journal of Islamic Financial Services1.2 (1999): 29-36.

34 Hisham, S., et al. "The Concept and Challenges of Islamic Pawn Broking (Ar-Rahnu)." Middle-East Journal of Scientific Research 13 (2013): 98-102.

35 Suleiman, Husam. "The Islamic Implication of the Standard Benchmarks in the American Islamic Mortgage Product." Journal of Islamic Banking and Finance, (Dec. 2015): p 25-29.

36 Evolution of the banning of Riba in the Quran as an example Critical Issues on Islamic Banking and Financial Markets, Saiful Azhar Rosly, 1st stage; moral censure of Riba (30:39) 2nd stage; consuming of wealth unjustly (4:161) 3rd stage; prohibition of multiplied usury (3:130) 4th stage; Alternative to Riba provided (2:275-281)


Unions were to change the paradigm of the role of the traditional brick and mortar bank. As a result, they became successful in their niche29.

4. Conclusion Often overlooked, in the initial mainstream ruling pertaining to mortgages, was the

recommendation to continue to work to create and support Islamic alternatives for financing. The last significant development [intro of Shari’ah-compliant contracts] brought to the market was over 15 years ago. This stagnation has allowed Islamic scholars to better understand the mortgaging mechanism, and as a result, issue a negative opinion concerning the GSE affiliated Islamic mortgages.

The current antipathy of the banking sector in America has resulted in American’s exploring alternative methods of finance. As a result, crowdfunding has emerged as a front-runner innovating the way Americans lend and borrow funds. Similarly, the upsurge in Islamic finance over the past decade is a direct result of discontentment with the conventional economic products37.

With the current rise and success of crowdfunding and the inherent Islamic attributes associated, the critical mass now exists to create the next paradigm of the American Islamic mortgages by pairing with crowdfunding.

Islamic finance product developers now have an opportunity to overcome the conundrum of creating products that merely mimics the competition [in substance and capacity], and create products that encapsulate Islamic principles such as altruism and mutuality. The opportunity does now exist to create a platform that embodies Islamic ideals which will have the potential to influence areas beyond that of economic activities.

37 Khan, Muhammad Akram. An introduction to Islamic Economics. Vol. 15. IIIT, 1994. p.30



Macro-prudential Supervision in the Indonesia Financial Services Authority (OJK) and the Role of Sharia Board: A

Proposed Framework By

Muhammad Iman Sastra Mihajat**

Abstract Recent global financial crisis has intensified the official sector’s interest in strengthening the macro-prudential orientation of current policy arrangements in particular for Islamic banking and finance sector. The crisis also has highlighted the issues in quality of regulation and supervision in the financial sector, and tested the effectiveness of current regulation and supervision in identifying and mitigating the risks faced by the conventional systems in various jurisdictions. With increasing complexity and the uniqueness of Islamic banking and finance, OJK has to adopt a more macro prudential framework to address systemic risks and Shari’ah risks. The paper proposes a new macro prudential framework by involving a new Shari’ah Board Authority (DPSN) under the Commissioners of OJK to regulate and supervise the Shari’ah matters for Islamic financial institutions in Indonesia. The paper discusses the challenges in adopting this new framework. The paper concludes that the current shortcomings of the macro prudential approach for Shari’ah supervision and regulation require a new Shari’ah Board Authority under the commissioners of OJK who has full authority over Shari’ah matters. Keywords: Macro prudential, Islamic banking and finance, DPSN-OJK

1. Introduction

Financial crisis in the last two decades (Asian financial crisis in 1997, subprime mortgage crisis in 2008, and Yunani crisis in 2015) have intensified the official sector’s interest in strengthening the macro-prudential orientation of current policy arrangements

* Author: Muhammad Iman Sastra Mihajat, Head of Shari’ah Audit and Shari’ah Compliance,

Islamic Banking Unit, Oman Arab Bank, Muscat, Sultanate of Oman. E-mail: [email protected]


in particular for Islamic banking and finance sector. These crises have highlighted the weaknesses and limitations of current supervisory and regulatory frameworks globally to predict the build-up of imbalances in the real sector and their resulting adverse impact on the conventional financial system. The recent financial crisis has signaled the need for Islamic financial system in particular in in the era of OJK for identifying and assessing a robust system and modifying the regulatory and supervisory framework for Islamic financial services to mitigate risks through macro prudential and micro prudential frameworks to ensure the stability.

Generally, micro prudential policy focuses to achieve the stability over the financial system through soundness and safety of individual financial institutions which is proven as not sufficient instrument. This approach only overlooks the interconnectivity of financial institutions and the complexity of financial transactions that arises through innovative financial products to allocate the risks across various market participants (Kardar, 2011).

Currently, in Indonesia, supervision and regulation of banking, capital market, insurance and other financial institutions are regulated and supervised by OJK (Indonesian Financial Services Authority) under Legal Act of OJK No 21 2011. There is an urgent need to develop effective macro prudential policies and frameworks in the arena of Shari’ah regulation and supervision as a tool to strengthen the resilience of Islamic financial system in Indonesia. Therefore, this paper will focus on the proposal of a new Shari’ah Supervisory Board Authority under the commissioners of OJK namely National Shari’ah Supervisory Board (DPSN-OJK, Dewan Pengawas Syariah Nasional Otoritas Jasa Keuangan). The paper also gives the comparison over the function of National Shari’ah Board Indonesian Council of Ulama (DSN-MUI), Shari’ah Supervisory Board in each individual Islamic financial institution and DPSN-OJK.

2. The Role of Macro prudential Policy and Supervision in the Era of OJK The huge tasks of OJK in supervising the multidimensional institutions has to come

with a new supervisory framework not only ensures the prudence, discipline and transparency in individual financial institutions, but also is able to identify system-wide risks including the Shari’ah and reputation risk of Islamic financial institutions. According to Kardar (2011), the overall of macro prudential approach is to limit the incidence of financial crisis and minimize the related costs to economy and the national exchequer. He further explained that the key components of a viable macro prudential framework comprise: a) a system-wide review of the risks to the stability of the financial system, and identification and analysis of the risks posed by the interconnectivity of financial institutions and market; b) analysis of business cycle to identify and address the risks from the procyclical and herd mentality tendencies of the financial system; c) identification of market failures that could result in financial crisis; d) definition of the specific roles of all key stakeholders, regulators and parallel institutions, government, central banks/OJK, and non-banking finance companies regulators in maintaining system stability on an ongoing basis.

There are several understanding and definition over the term macro prudential. The FSB, IMF, and BIS (2011) define macro prudential policy as a policy that uses primarily prudential tools to limit systemic or system-wide financial risk and limit the incidence of

Macro-prudential Supervision in the Indonesia Financial Services…….


disruptions in the provision of key financial services that can have serious consequences for the real economy, by:

- Dampening the build-up of financial imbalances and building defences that contain the speed and sharpness of subsequent downswings and their effects on the economy;

- Identifying and addressing common exposures, risk concentrations, linkages and interdependencies that sources of contagion and spillover risks that may jeopardize the functioning if the system as a whole.

The FSB, IMF, and BIS (2011) further explain that macro prudential policy is a complement to micro prudential policy and it interacts with other types of public policy that have an impact on financial stability. Although there are many policies that impact into financial stability, but not all such policies should considered macro prudential policy.

Therefore, macro prudential policy focuses on the soundness and stability of the financial system as a whole while micro prudential policy only focuses on the risk of each individual institution. Carosio (2010) explains that macro prudential policy proposes to limit the incidence of financial crisis, promote financial stability and preserve the integrity of financial markets by mitigating systemic risk, protecting and safeguarding the whole financial system, and maintaining the flow of financial services and payment systems. He further elaborate that since the systemic risks are classified as negative externalities, therefore these risks are not internalized and have tendency to disrupt financial services and create spillover effects in the real economy. This risk is imperative to be seen in a dynamic context for financial stability not only at each point in time. Borio (2003) laid down differentiation between the micro prudential and macro prudential perspective in terms of objectives and the model used to describe risks (Table 1).

Table 1 Macro prudential versus Micro prudential Policies

Macro prudential Policy Micro prudential Policy

Proximate objective. Limit financial system-wide distress.

Limit distress of individual institutions.

Ultimate objective. Avoid macroeconomic costs linked to financial instability.

Characterization of risk.

Characterization of risk. “Endogenous” (dependent on collective behavior).

“Exogenous” (Independent of individual agents’ behavior).

Correlation and common exposures across institutions.

Important. Irrelevant.

Calibration of prudential controls.

In terms of system-wide risk: top-down.

In terms of risks of individual institutions: bottom-up.

Source: Borio (2003)

As explained above, the macro prudential policy considered as early warning signals that will assist OJK/regulators to adopt countercyclical credit and monetary


policies to avoid the build-up bubbles in boom periods and helps to check credit crunch and supply shocks in deteriorating economic conditions. However, OJK need to set what are the policy tools in carrying such supervision and surveillance in which sometime requires changes in current prudential regulation, monetary policy conduct, and the banking law.

The Basel Committee on Banking Supervision (BCBS) proposes to change the capital requirements to provide a buffer in a countercyclical manner for prudential regulations of OJK for Islamic financial institutions that may be determined on the basis of size, complexity, and connectivity with the rest of financial system and the real economy. This regulation has the objective to minimize the spillover effects, building of credit bubbles, asses the preparedness and resilience of the financial system to real sector shocks resulting impacts on the financial sector and the impact to the real sector. The changing capital requirement can be enhanced during credit booms and relaxed during crunch times.

There are many macroprudnetial instruments that are found to be effective in mitigating systemic risk. C. Lim et al (2011) suggest the following instruments based on the experience of 49 countries that may help dampen procyclicality including; caps on the loan-to-value ratio, caps on the debt-to-income ratio, ceilings on credit or credit growth, reserve requirements, countercyclical capital requirements and time-varying / dynamic provisioning. Committee on the Global Financial System (CGFS) (2010) provides on a limited basis in the region a macro prudential policy tools as being used by Asian Countries as a macro approach to minimize the wide-risk during 1997-1998 crisis (Table 2).

Table 2 Macro prudential Tools: Experience of Asian Economies

Objective Tools Countries Countercylical capital buffers linked to credit growth.

China.

Countercylical provisioning. China and India.

Financing (Loan) to value (FTV) ratios.

China, Hong Kong, Korea, Singapore, Philippines, and Malaysia.

Manage risk over time (procylicality)

Direct Controls on lending to specific sectors. Singapore.

Capital surcharges for systemically Important Financial Institutions (SIFI).

China, India, Philippines, and Singapore.

Caps on leveraging, levy on non-core liabilities. Korea.

Liquidity / funding requirements.

Korea, Philippines and Singapore.

Limits on currency mismatches.

India, Malaysia and Philippines.

Manage aggregate risk at every point in time (systemic oversight).

Financing (Loan) to deposit or income. China and Korea.

Source: CGFS (2010)



The above table shows how macro prudential tools and instruments may be used for any regulators to play a role in enhancing the resilience of the financial system against vulnerabilities. Since every crisis has its own idiosyncrasies on the impact on different sectors and its causes and causes, therefore, the regulators shall now how to use the above tool, what kind the appropriate tools to use so as to strike the right balance between risk mitigation and efficiency and when to activate the tool in each national jurisdiction. This has been emphasized by the BIS, IMF and BIS (2011) that the existence of macro prudential policy not to substitute the current micro prudential policy. It means macro prudential policy complements current micro prudential policy.

The role of OJK in this macro prudential policy arena is of critical importance, as it has mandate to maintain financial and payment system stability. Moreover, since the macro prudential framework has the objective to achieve financial stability overtime, it would assist OJK not only to ensure financial stability, but also to support price stability over a long-term horizon by maintaining the supply of credit during various phases of business cycle (Kardar, 2011).

In addition to OJK, the Ministry of Finance (MoF) is also considered as a major player in the design and monitoring of a macro prudential framework. MoF as a representative of the government is one of the biggest stakeholders in the financial system which can be borrower, depositor, policy maker, and lender of last resort (in case of a large system-wide crisis). One of it is a fiscal policy, this policy if not design properly, poor decision and manage it in appropriate manner will undermine financial stability since it is one of risk in the financial system. The role of MoF as a government institution can become an automatic stabilizer and financial supporter during distress period for financial institutions to minimize the cost of economy such as fiscal buffers, reduction level of debt, bailing out mechanism and expansionary fiscal policies during demand period.

Therefore, it is important to have an academic research and discussion among the supervisory authorities to design the effective mechanisms in stabilizing the financial system. Although the macro prudential policy is still being debated, the need for a new Shari’ah framework in the new era of OJK in Indonesia is an urgent demand to maintain the robustness of Islamic financial institutions.

3. The Future of Islamic Banking and Finance in Indonesia in the era of OJK The Islamic financial system in Indonesia has grown substantially in the last

decade, benefiting from multi-dimensional financial reforms that were initiated in 2008. This reform shows the commitment of Indonesian government to support the development of Islamic banking and finance in the country. This is the first time while the word “Shari’ah” is written in the legal act of Indonesia since the establishment of the first Islamic banking in Indonesia in 1992. In 2011, the Indonesian parliament has been endorsed the new Act No 21 2011 regarding the supervision of financial institution would be took over by a new authority namely OJK (Otoritas Jasa Keuangan, Indonesian Financial Services Authority) from Bank Indonesia (Central Bank of Indonesia).

Prior to endorsement of this act, the regulation and supervision of banking institution would be under Bank Indonesia, however after this endorsement, OJK will


take over the supervision which not only cover Islamic banking institution but also Takaful (Islamic Insurance) company, Islamic capital market, and non-financial institution like Islamic leasing company, BMT and cooperative. These reforms aims to enhance the soundness of financial system, improving quality of supervision, broadening and deepening the financial system.

Although the specific regulation and supervision of Islamic financial institutions in the Act No 21 2011 on financial services authority does not mentioned specifically. Many people are questioning the commitment of Indonesian government in supporting the Islamic finance industry in the country. However, under the supervision of OJK after its establishment since 2011, start operation in 2012, the Islamic financial system in Indonesia has grown substantially in this era, the total Indonesia’s Islamic Financial assets as per December 2013 reached Rp.576 trillion or about US $414.4 billion with composition of ± 52% of Islamic banking, ± 35% of sovereign Sukuk (SBSN) and ± 8.8% of Islamic non-bank financial industry, with Indonesia’s Islamic finance market share still below 10% (OJK, 2012).

In addition, according to E&Y (2013), a report related to the development of global Islamic finance, Indonesia with Malaysia, Saudi Arabia and the UAE, are among few countries which will become the driving factors behind the next big wave in Islamic finance in the world as well as in the position to offer lessons to other nations seeking to build their own Islamic Finance capacity. With the big of Muslims’ population in the world, many countries in particular Muslim Countries expect Indonesia can become an Islamic Finance Hub in the global.

4. A New Proposal for Shari’ah Regulatory Framework in the Era of OJK In the era of OJK, it is important to have Shari’ah Board under the commissioners

of OJK that have full authority on Shari’ah matters that regulate and supervise Islamic Financial Institutions (IFIs). The existing framework of Islamic finance in Indonesia is each Islamic financial institution obliged to appoint Shari’ah Supervisory Board (SSB, Dewan Pengawas Syariah, DPS). The SSB is appointed by the general assembly of shareholders and recommended by the Board of Commissioners meeting, SSB candidates shall get approval from OJK (previously Bank Indonesia) and recommended by National Shari’ah Board Indonesian Council of Ulama (Dewan Syariah Nasional Majlis Ulama Indonesia, DSN-MUI). The SSB is the extension of the hand of DSN-MUI in maintaining and supervising the Shari’ah matters in each individual Islamic financial institution. The SSB is not only independent from the Board of Commissioners but also allowed to attend the Board of Commisioners’ meeting to discuss the Shari’ah aspects of their decisions (AAOIFI, 2005).

In general, the aims of SSB are to guide the IFIs in the setting of Shari’ah policies and regulations, to approve Islamic banking and finance products and policies that in accordance with Shari’ah, and proposed a proper Islamic contract that can be used by Islamic bank (Daoud, 1996; Hassan and Chachi, 2007). The SSB members represent the IFIs in the general meeting and explain any Shari’ah matters to the stakeholders. In addition, the SSB members will provide advice to the Board of commissioners and the top management on Shari’ah issues.

In brief, the existing Governance Framework for Islamic financial institutions does state Shari’ah Governance Framework in a specific manner. Bank Indonesia only circulate one circular letter that regulate Good Corporate Governance for Full-fledged


78 Journal of Islamic Banking and Finance Oct – Dec 2016 Islamic bank and Islamic windows No. 11/33/PBI/2009 that cover 6 points including: i) duty and responsibilities of Board of Commissioners and Board of Directors; ii) completed committee and function for internal control; iii) duty and responsibilities of Shari’ah Supervisory Boards; iv) application of compliance, internal audit and external audit function; v) maximum limit to distribute fund; vi) financial and non-financial transparency.

The good point in the era of OJK is that, all Islamic financial institutions regulated and supervised under one umbrella, OJK not only regulate and supervise Islamic banking like in the era of Bank Indonesia, but also Islamic capital market, Islamic insurance, BMT, Islamic cooperative, venture capital etc. In the era of OJK, there are three points that author expected to happen, first, the development of Islamic financial institutions would be more optimal, second, Indonesia can become International hub for Islamic finance in Asian and Middle East Countries (AMED) and third, Indonesia has to be a trendsetter for Islamic finance industries globally.

Therefore, the paper suggested that OJK shall set up the Shari’ah body that regulate and supervise the Shari’ah matters for Islamic financial institutions in Indonesia namely National Shari’ah Supervisory Board of OJK (NSSB-OJK, Dewan Pengawas Syariah Nasional, DPSN-OJK) under Board of Commissioners of OJK.

What is DPSN-OJK? What are the differentiations between DPSN-OJK and SSB and DSN-MUI? According to Mihajat (2011), DPSN-OJK is National Shari’ah Supervisory Board in Indonesia Financial Services Authority framework. This body is under line of the Board of Commissioners of OJK that has the duty to supervise and regulate Islamic finance products that have been circulated in the market or propose a Shari’ah regulation for a new product in Islamic financial institutions (IFIs). The DPSN-OJK has the right to review the existing products of IFIs in the market and decide either it is complied with Shari’ah, or has the authority to stop the marketing of the existing product that is not Shari’ah compliance.

The role of DPSN-OJK is to help the development of Islamic finance industry in Indonesia, DPSN-OJK also has to conduct a meeting on weekly or monthly basis as per required, there are several point of discussions as the role and responsibilities of OJK including as follows:

1. Review existing products in IFIs, either Islamic bank, Islamic insurance, Islamic capital market, and other IFIs under supervision of OJK, to maintain Shari’ah-based product. To decide either Shari’ah compliance or not it has to be based on 2/3 decision of the DPSN-OJK members (ijtihad jama’i).

2. Review existing products that has been complied with Shari’ah to see either this product is able to disrupt economic system in general or kill the real sector of economy. DPSN-OJK will decide Such as Gold Pawn Broking in Islamic banks that merely lead to speculation rather than investment.

3. Discuss the proposed products by IFIs either has been complied with the Shari’ah rules. If the proposed product is normal product and easily understood, the DPSN-OJK will endorse quickly. If the proposed product is relatively new and using a new structure of ‘aqad, DPSN-OJK will take time to endorse the proposed product, this endorsement shall be based on research a proper instinbatul ahkam (deriving a Shari’ah rule from its sources) that refer to a Shari’ah sources such as al-quran, al-hadith, ijma’, qiyas, istihsan,


masalih mursalah, saddu al-dzariiah, qaulus shahabi, and syar’un man qablana).

4. Proposed a new product with a proper Shari’ah structure that demanded by the Islamic finance market so that IFIs can be a competitive nationally and internationally. By endorsement of this product, international investor such as Asia, Europe, and Africa will invest their fund in Indonesia as Indonesia well-known as International hub in Islamic finance.

5. Establish cooperation with Internal Shari’ah Standard such AAOIFI, IFSB, ISRA and International Shari’ah Board Association to exchange an idea and sharing idea among the Shari’ah Scholars in developing IFIs in Indonesia so that become a trendsetter and international center for Islamic finance.

From above duties and responsibilities, Indonesia can expect Islamic finance market share will grow better than before. This regulation has to have a support from Government of Indonesia so that a proper proposed framework is not useless.

The paper suggested a new Shari’ah Governance Framework of OJk as described in the figure 1. From the figure we can see that the position of DPSN-OJK is under line of Board of Commissioners of OJK which has full authority in determining the Shari’ah aspect of the products and the institutions. This framework shall support by special Government Regulations (PP, Peraturan Pemerintah) that describe the authority of DPSN-OJK so that any decision issued by them is binding and far from the conflict of interest. The figure also explain that DPSN-OJK oversees the Department of Islamic Capital Market, Islamic Banking, Islamic Insurance and other IFIs. Each department will regulate and take care the IFIs under its line including product development. If one Islamic bank proposed one product to OJK, this product shall go first to Islamic Banking Department in OJK, Islamic Banking department will review either the product is possible to go to the upper lever (DPSN-OJK). If the product is worthy, the Islamic banking department will pass to DPSN-OJK, otherwise, it will return back to the respected IFI who proposed the product to revise back and send back to Islamic banking department of OJK.

Figure 1 Shari’ah Regulatory Framework of Islamic Finance in the Era of OJK



a) Top Down Approach Model The first model, the product normally proposed by DSPN-OJK where they see that

the product is seen to be important for development of Islamic finance in Indonesia. First step, DPSN-OJK will proposed in the weekly/monthly meeting among the members and design the product so that can be applied. For example, DPSN-OJK proposed Islamic structured product instrument that can be used by Islamic banks, Islamic capital market entities, Takaful companies to diversify their investment portfolio. If it is approved among the members, this product will be circulated among the IFIs. The IFIs can start to use the product without any new approval from DPSN-OJK, IFIs just need to inform to OJK to get his approval.

b) Bottom-Up Approach Model

The second model is that bottom-up approach model, this model normally used by Islamic banking industries to Bank Indonesia. Shari’ah compliance unit will coordinate with product development unit to structure a new product as per demanded by the market. If Shari’ah compliance has been discussed and approved the product, this product will go to Shari’ah Supervisory Board for their discussion and approval. If in the SSB meeting the SSB members approved the product, this product will go to Islamic banking department of OJK, Islamic banking department of OJK will review the proposed product, if they see this product is possible to bring it to DPSN-OJK meeting. The product will go to the higher level of meeting and go to the DPSN-OJK meeting. DPSN-OJK will review and decide either the product is Shari’ah compliance or it will return


back to Islamic bank for their rectification and revision in case if there is a Shari’ah issues. Islamic bank will submit back the proposed product until it is complied with Shari’ah and approved by DPSN-OJK.

Is it possible for DPSN-OJK become A SSB in Islamic Financial Institutions?

There are would a lot of question come up from the Islamic finance stakeholders, is it permissible for DPSN-OJK members to become a SSB members in Islamic Financial Institution such as Islamic bank, Takaful companies, Islamic capital market entities and other IFIs. Therefore, the paper suggest that the government has to issue the regulation saying that it is not permissible for DPSN-OJK members to become a member of SSB in IFIs to avoid a conflict of interest among DPSN-OJK members due to that one of them is representing one of IFI.

Who is the right Person to be a Member of DPSN-OJK? OJK is expected to regulate what are the requirements to become a member of

DPSN-OJK so that only a qualified person who appointed to seat in this position. The criteria for the members of DPSN-OJK are including as follow:



1. Members of the DPSN-OJK have to be Muslim individuals.

2. Members of the DPSN-OJK with Shari’ah background must be holders of academic qualifications in the field of Shari’ah –minimum bachelor degree- that include study in Ushul Fiqh (Rules of Islamic Jurisprudence) and Fiqh al Muamalat (Islamic Commercial Transactions) from a recognized institution. They should be able to demonstrate an adequate understanding of Islamic banking, Islamic capital market, Takaful and other IFIs.

3. Members of DPSN-OJK must have more than 2-5 year experience in Islamic finance industries (teaching, research and fatwa issuance). They should be able to demonstrate strong proficiency in Arabic, since most literature of Islamic banking and finance are written in Arabic.

4. Members of DPSN-OJK must have a respectable character and be of good conduct and moral values, particularly in terms of honesty, integrity and reputation in their professional business and financial dealings.

5. Members of DPSN-OJK must have commitment to develop Islamic financial institutions industry.

The above requirements are proposed to maintain the reputation of OJK as the regulator of Islamic financial institutions so that the credibility of OJK will be maintained in a proper manner.

The Role of DPSN-OJK, DSN-MUI, SSB in the Era of OJK As elaborate in the above discussion, the role of DPSN-OJK is different with DSN-

MUI and SSB in each of Islamic financial institution. DPSN-OJK has the authority to decide either the product in IFIs in compliance with Shari’ah, review the proposed product form IFIs either to reject or to approve and the regulation issued by them are binding to all IFIs. While DSN-MUI is still stick with their rule which is issuing the Fatwa for IFIs, and SSB is responsible to maintain the Shari’ah compliance of business activities, transactions and product in which they seat in a particular IFIs (please see Table 3).

Table 3: The Different between DPSN-OJK, DSN-MUI and SSB

Institution Authority Fatwa/Regulation Issued

DPSN-OJK. OJK.

Decide to approve or reject a proposed product from IFIs.

Binding to all IFIs.

DSN-MUI. Independent. Issue the Fatwa of IFIs. Not binding in

nature.

SSB.

IFIs (Islamic Bank, Islamic Capital Market Entities, Takaful Companies or other IFIs.).

- Approve a proposed product in a particular IFI. - Ensure that a particular IFI is in a compliance with Shari’ah.

Binding to a particular IFI where they seat as a SSB Members.


In general, the roles and responsibilities of DPSN-OJK are clear and different with

DSN-MUI. Among the duties of DPSN-OJK are:

1. Grow and develop the implementation of the Shari’ah values in economic activity in general and finance in particular.

2. Issuing fatwa on the aspect of financial activities.

3. Issuing a fatwa on Islamic financial products and services.

4. Oversee the implementation of the fatwa has been issued.

While the role of DSN-MUI are: 1. Issue a binding fatwa to Sharia Supervisory Board in the respective Islamic

financial institutions and the basis of legal action related parties.

2. Issuing fatwas that became the basis for the provisions / regulations issued by the competent authority, such as the Ministry of Finance and Bank Indonesia/Indonesia Financial Services Authority.

3. Provide recommendations and / or revoke recommendation names that will sit as Sharia Supervisory Board at an Islamic financial institution.

4. Inviting experts to explain a problem that is necessary in the discussion of Islamic economics, including monetary authorities / financial institutions within and outside the country.

5. Provide a warning to the Islamic financial institutions to stop the irregularities of the fatwa issued by the National Shari’ah Council.

6. Propose to the relevant authorities to take action if the warnings are not heeded (DSN-MUI, 2012).

From the above of roles and responsibilities, each DSN-MUI and DPSN-OJK have their respective roles in the development of the Islamic finance industry without overlap one another. Thus, the emergence of DPSN-OJK is not something that needs to be debatable.

Sharia Supervisory Board The next issues arise is that whether the existence of DPSN-OJK will affect the role

and responsibility of SSB in every Islamic financial institution? Surely not, because their respective institution is very different one another, where SSB in each Islamic financial institution only entitled to supervise the products and regulations relating to Shari’ah of a particular Islamic financial institution, while DPSN-OJK has the authority to impose regulations generally for all Islamic financial institutions in Indonesia.

As we know, in general, it is has been mentioned that the role of SSB in each Islamic financial institution are:

1. The Sharia Supervisory Board has to perform periodic monitoring/supervision on Islamic financial institutions in which they are seated.



2. The Shari’ah Supervisory Board is obliged to submit product proposals to the BOD or BOC of that institution and report to DSN-MUI.

3. The Sharia Supervisory Board reported on the development of products and operations of Islamic financial institutions that under their supervision to the DSN-MUI at least twice in one budget year.

4. The Sharia Supervisory Board formulates the problems that need to be discussed in National Sharia Council.

From the explanation above, it is clear that DPSN-OJK with the DPS in Islamic financial institutions is quite different in the roles and responsibilities to one another.

Conclusion The primary aim of macro prudential supervision in the era of OJK is to mitigate

the stress on the entire financial system, which could have a heavy macroeconomic cost in the form of expensive bank-bailouts. The current Islamic financial system in Indonesia in the era of OJK has changed in a way that all IFIs including Islamic banks, Islamic capital market entities, Takaful companies, and other IFIs are supervised and regulated by Indonesia Financial Services Authority. There is strong recognition that some of the risks faced by the financial system are different from those faced by an individual institution. In particular, IFIs have unique risks compared to conventional entities. Therefore, the Shari’ah governance framework system in Indonesia in the era of OJK needs to be reformed.

The paper has given one proposed Shari’ah Governance Framework by adding DPSN-OJK (National Shari’ah Supervisory Board) under Board of Commissioners of OJK who has the full authority in Islamic finance industries on the Shari’ah matters. Since the role of Shari’ah board in ensuring the Shari’ah compliance of the IFIs is very important, the existence of DPSN in OJK would be more helpful for OJK to supervise and regulate the IFIs so that the members of DPSN-OJK can decide a Shari’ah matter based on a majority basis which is tantamount to collective ijtihad.

References AAOIFI. Bahrain: AAOIFI (2005).

AAOIFI. “Sharī� ah Standards for Islamic Financial Institutions. Shari’ah Standard No. (25): Combination of Contracts. Bahrain: AAOIFI (2007; 2008).

Borio, Claudio. “Towards a Macro prudential Framework for Financial Supervision and Regulation?” BIS Working Paper 128, (2003).

C. Lim, F, Columba, A. Costa, P. Kongsamut, A. Otani, M, Saiyid, T. Wezel, and X. Wu. “Macro prudential Policy: What Instruments and How to Use Them? Lesson from Country Experiences.” IMF Working Paper (2011), WP/11/238/.

Corosio, Giovanni. “Financial Stability and Macro-Prudential Supervision: Challenges for Central Banks.” OeNB Economic Conference (2010). www/oenb.at/en/img/paper_carosio_tcm16-193932.pdf


Dewan Syariah Nasional Majlis Ulama Indonesia (National Sharī� ah Board of Indonesia

Council of Ulamā) (2012). Himpunan Fatwa Dewan Syariah Nasional MUI (The Fatwas Compilation). Jakarta: Dewan Syariah Nasional and Bank Indonesia.

Ernst & Young. The World Islamic Banking Competitiveness Report, 2013 - 2014, Transition Begins, GIFR report 2013.

FSB, IMF and BIS. “Macroproduential Policy Tools and Frameworks. Update to G20 Finance Minister and Central Governors.” BIS (14 February 2011).

Hassan, Abul & Chachi, Abdelkader. “Corporate Governance of the Islamic Financial Services Industry in Brunei Darussalam.” Journal of Islamic Economics, Banking and Finance (2007).

Mihajat, Muhammad Iman Sastra. “Masa Depan Industri keuangan Syariah di Era OJK, A New Proposal.” Article published in Sharing Magazine (March 2012).

OJK. Press Release Indonesia International Conference on Islamic Finance 2014, Surabaya, 3 - 4 November 2014.



Effect of Quality of Services, Bank Image, Religious Perspective on Bank Customer

Loyalty (A mediator role of customer satisfaction)

By Amin Ur Rahman∗

Abstract with the liberalization of economic sector of Pakistan and introduction of Islamic banking system, the industry become more competitive as the consumers have more choices and thus their preference changed toward banking. In this increasing high competitive industry, Bankers are more focus on customer loyalty to win market share and thus gain competitive advantages. The purpose of this paper is to identify those core factors that influence customer loyalty in the banking sector of Pakistan.

The paper examines three independent factors i.e. Bank services, Bank reputation and religious perspective along with a mediator factor which is customer satisfaction that ultimately results in gaining customer loyalty. This study was carried out by taking a sample size of 260 participants and a structured questionnaire of 35 items was used to collect data and analysis was done using SPSS (edition 22) software. The Result of the study shows that there is a positive relation amongst Bank Services, Bank Image and Religious Perspective on customer satisfaction which directly leads to customer loyalty. With the help of this study we found that Bank service is considered as a most prominent factor that leads to customer satisfaction and customer satisfaction leads to customer loyalty. This study is helpful for policy makers and bank managers to know customer satisfaction thus they can earn more customer loyalty.

Key words: Customer Loyalty, Customer Satisfaction, Bank Services, Bank Image, Islamic Bank

∗ Author: Amin Ur Rahman , MS scholar, Faculty of Management science, International

Islamic University Islamabad. Email: [email protected]


Introduction Economic liberalization and advancement in technology like cell phones, internet

and all other means of communication brought tough competition among the companies and especially in the banking sector. As we all know that there is a little difference between product and services which are provided by the banks,therefore it is a big concern for a banks to get competitive advantage in this highly competitive environment. In this high competitive industry, customers’ needs are critical, so companies always try to keep their product and services according to the requirement of their customer. They cannot afford losing even a single customer because losing a customer means gaining of a customer by your rival, hence in this market competition aggressive strategies for attracting new customers and defensive strategies in order to establish customer loyalty become vital (Miles, 1994). Thus financial institution should be more careful and more aware about all those factor that lead to customer satisfaction in order to attain Customer Loyalty (Pont and Mcquilken, 2005).

Customer loyalty is an important factor for any business and especially in high competitive industry. Oliver (1999) defines customer loyalty as extensively held commitment to repurchase a preferred product or services regularly in future. It is actually an emotional attachment of the customer toward a particular company's product and service that arises when product or service are according to the customer demand and requirement. Loyalty has been a real concern in banking industry because of high expectation of the client and tough rivalry (Rasheed, Sajid, Shahid & Ahmad, 2015). Customer Loyalty is the result of customer satisfaction. Customer satisfaction is a marketing terminology that explains to what extend a firm’s product or service fulfills the need of its customers. It is a key factor for an organization when it faces competition in the industry. According to Hassan, Chachi & Abdul Latiff (2008), when an organization is unable to meet the customer needs, it will cause huge fall in profitability as well as decrease in market share.

Researchers have identified various factors that effects bank selection and customer satisfaction. When we are talking about service industry like banking, the quality of service is most important factor that s customer satisfaction or dissatisfaction. According to Ahmossawi (2001), quality is key factor in banking business as it leads to high level of customer satisfaction. Bei and Ciao (2001), identified that service quality has positive association with customer which mean that to satisfy customer needs will get you loyalty. In addition to quality of services, bank image and reputation also influence customer satisfaction which is also considered in the study. Empirical studies have confirmed that bank image effects customer satisfaction and as a result leads to customer loyalty (Bloemer and Ruyter, 1998). Another Important factor in Islamic world is Islamic mode of banking that attracts huge number of customer. As per Islamic rule, Interest is prohibited in Islam and all convention banks are working on interest base. So Islamic banking is much more acceptable banking system for Muslim and that is why key international banks are interested in operating Islamic banking because Muslims are one fifth of total world population (Ashraf, 2014). In addition, majority of Non-Muslims are using Islamic banks (Ngui 2004; saifuddin, 2003). So besides religious factors bankers should adopt other factors that influence customer satisfaction in order to survive in the competition with conventional banks.

Effect of Quality of Services, Bank Image, Religious Perspective ……..


With that much competition on going, the bankers are very much concerned about retaining their old customers and as well as attracting new clients. According to a research attracting new customer is about five times more expensive than keep existing one because for new customer they have to advertise themselves through banner, television commercials, internet which cost them more. On the other hand existing customer just need better services. Previous literature shows that a lot of work has already been done in respect of customer satisfaction and customer loyalty but there are limited studies found of religious perspective particularly in context of Pakistan (Abduh & Alobaad, 2015). In addition Awan and Mazhar(2014), reveal that many customer criteria of selection of bank is influence by religious perspective. To fill the gap we added religious perception factor in our study and tried to find its relation on customer satisfaction and customer loyalty. Previous studies are narrowly focused on relation between customer satisfaction and customer loyalty so here we tried to explain our study in broader terms i.e. explain factors that affecting customer satisfaction and then explain the relationship of customer satisfaction and customer loyalty. The study will increase present literature because it shows clearer picture regarding customer satisfaction and thus will help the policy makers and banker to get better knowledge about customer satisfaction and customer loyalty.

The objective of this paper is to identify those factors that affect customer satisfaction in banking industry e.g. quality of services, bank image and religious perception. And also explain the combined effect of these factors on customer loyalty by keeping mediator role of customer satisfaction. In this research we considered different banks of twin cities i.e. Rawalpindi and Islamabad of Pakistan and a 35 items questionnaire survey of 260 respondent was conducted to collect data for our analysis. The basic question of study is what are the most influencing factors that lead to customer satisfaction and customer loyalty?

Literature Review Customer Loyalty

In current competitive business conditions and especially in case of banking sector, maintaining customer loyalty is big concern because it becomes deciding factor to win over competition. Customer loyalty is actually customer's deeply held commitment to re-purchase particular products and services from the same firm and organization in future. It is actually strong affiliation of the customer with the firm when the firm is constantly fulfilling the customer requirement and needs. According to Oliver's ( 1999,p.34) definition of customer loyalty is; " a deeply held commitment to rebuy or patronize a preferred product/service consistently in the future, thereby causing repetitive same-brand or same brand-set purchasing, despite situational influences and marketing efforts having the potential to cause switching behaviour”.

Recent researches classify customer loyalty into different marketing feature i.e. product loyalty, service loyalty, brand loyalty and chain & store loyalty. Many previous published literature define three basic dimensions of loyalty (Filip and Anghe 2009). These dimensions include: behavioural loyalty, attitude loyalty and composite loyalty (integrated loyalty). Krisnamuthi & Raj, (1991) measure Behavioural dimensions that explain those customers who are habitually loyal. These customers are loyal to a company when they buy from it and continue to rebuy in future because switching from


one brand to another brand is a problem for these kind of customers. According to these researchers, behavioural loyalty defines narrow understanding of the underlying re- buying factors. Another drawback of this approach is that repeat purchase does not always happen as the result of emotional commitment toward the brand (Tepeci, 1999). The outcomes of behavioural loyalty is repurchasing the same brand (Zeitham et al. 2006; jones et al. 2000) and as the result lower chance switching behaviour of the customer (Bansal and Taylor, 1999). On the other hand attitudinal loyalty define loyalty as state of mind. These researchers explain that a customer is called to be "loyal" when they have optimistic attitude toward product or company. Attitudinal loyalty is loyalty that arises because of positive attitude of the customer toward brand and as a result customers develop trust in that brand which means that they are happy to be loyal customer of that company and brand

Composite loyalty is actually composition of both attitude and behavioural dimensions and this dimension measures loyalty by customer preferences toward brand, tendency of brand switching, and frequency of purchase (Pritchard and Howard, 1997; wong at al., 1999).

In Pakistan banking scenario, where numerous private and public banks are doing business in the industry with similar product characteristics, it is a difficult for bankers to get market share and competitive advantages. So customer loyalty in this kind of industry is key factor to retain old customer as well as attract new customer.

Customer Satisfaction and Customer Loyalty: Customer satisfaction is a frequently used marketing terminology which means to

what extend product and service offered by a firm or company fulfil customer expectations. According to Ashraf (2014) customer satisfaction is actual feelings or attitude that a customer possess when their needs and expectation are satisfied by superior quantity that lead to overall service satisfaction. Kotler (2013, p. 13) defines customer satisfaction as “customer satisfaction depends on the product's perceived performance, relative to buyer expectations. If the product's performance falls short of expectations, the customer is dissatisfied. If performance matches expectations, the customer is satisfied, if the performance exceeds expectation, the customer is highly satisfied or delighted”. Oliver (1980) stated that customer satisfaction is actually a model that explains the comparison of customer’s actual perceived product and services performance with their expectation then the feeling of satisfaction or dissatisfaction arise.

Any difference between expectation and performance will generate disconfirmation. Oliver (1980) identified three types of disconfirmations. When actual product and services outperform the customer's original expectation, the disconfirmation is positive and results in positive disconfirmation and customer satisfaction and post-purchase of that product and service. Negative disconfirmation arise when actual offered product and services disappoint the customer's anticipation which causes customer dissatisfaction and decreases future purchase of that product and services. The last disconfirmation is when actual product and service performance is equal to customer expectation.

If a firm is looking to achieve customer loyalty, it should first satisfy customer demands and needs because in current economic environment and particularly in banking sector where the products are almost the same,the only way to win the customer is to



offer best level services that meet customer expectations. In this kind of industry gaining new customer is too costly because of advertisement and promotion expenses where existing customers just need better services. Research show that it is 5 times more expensive to attract new customer. Past literature shows that there is significant positive relation between customer satisfaction and customer loyalty. According to these studies, customer satisfaction by providing better quality services leads to customer loyalty. According to Horstmann (1998), there is positive relationship between customer satisfaction and customer loyalty. A customer is loyal when he is satisfied by product and service provided. Other studies (Ismail, Hasnah, Ibrahim, & Isa, 2006; Da Silva & Alwi, 2006; Huat et al. (2012); He and Song, 2009) also identified customer satisfaction as defining factor of customer loyalty. These studies found that there is strong positive association prevailing between customer satisfaction and customer loyalty which leads to customer rebuy intention, positive word of mouth and ultimately increase in profitability. This leads to the following hypothesis

H1: there is positive relationship between customer satisfaction and customer loyalty

Quality of services, Customer satisfaction and Customer loyalty: Service quality is considered as a key factor in the success of any tangible or

intangible product offered by businesses particularly in service industries like banking, health and insurance.The competition among these industries is very high and the only factor to win customers is to provide better service quality which differentiates an organization from its competitors. Kotler and Armstrong 2013 define services as “an activity, benefit, or satisfaction offered for sale that is essentially intangible and does not result in the ownership of anything". Service quality is defined as to what extend your perceived service meet customer expectation. It is actually functioning like a bridge between customer and the organization which involves internal organizational policies and practices that lead to customer satisfaction and customer loyalty. The more a company provide better quality services than its competitors, the more its customer will be satisfied and loyal to the company and result would be an increase in profitability and victory of market share in the industry. According to Rust, Zahorik&Keiningham (1997), the best way to increase a company’s profitability is to develop better long run customer relations to make them loyal by investing in service quality.

Now the question is how we can examine our service quality is satisfying customer or not? The answer is explained by SERVQUAL model that is presented by Parasuramna et al. 1988 which defines five dimensions of services that is Tangibility, Reliability, Responsiveness, Assurance and Empathy. Tangibility means tangible components like appearance of equipment, physical facilities and personnel. Reliability means ability to deliver services correctly. Responsiveness is willingness of employees to help customer and deliver swift services, Assurance means that employees have relevant knowledge and provide services in polite and courteous manner. Empathy focuses on taking good care of customer. Unlike manufacturing business, banking sector has direct interaction with customer, so satisfaction or dissatisfaction is determined by quality of services. Cronin and Taylor 1992 has identified four services offering business where perceived service quality has positive influence on customer satisfaction i.e. banking, dry cleaning, pest control and fast foods. Customer satisfaction is a broader term that effects service quality (Ziethaml and Bitner, 2002). Services quality is an antecedent of customer satisfaction


(Gotlieb et al., 1994; Buttle, 1996; Zeithaml and Bitner, 1996; Lee et al., 2000) and customer satisfaction mediate the relationship between customer loyalty and service quality (Caruana, 2002; Fullerton and Taylor 2002). Service quality defines customer satisfaction or dissatisfaction; if a customer is satisfied, he will consume the services in future or otherwise he will switch off. However Jamal and Anatassiaduo (2007), Rizan (2010), Clottey et al. ( 2008) and Kheng et al. (2010) also revealed direct positive relationship existing between service quality and customer loyalty. In this regard, various studies identified positive relationship between customer satisfaction and service quality however some studies recommend that services quality is a part of customer satisfaction (Fornellet all. 2004). For banking industry and other service offering business, service quality is an important factor to differentiate one organization from another and help them to earn competitive advantages in the industry.

H2: Bank service quality has positive effect on customer loyalty

H3: Service quality has positive effect on customer satisfaction

H4: Customer satisfaction mediates the relationship between customer loyalty and service quality

Religious perspective, customer satisfaction and customer loyalty:

Islamic banking can be defined as “A banking system which works on the basic principles of Islamic law which are called Shariah and direct Islamic economics. A definition which is presented by Ali & Sarkar (1995) and also approved by OIC explains Islamic banking in following manner " An Islamic Bank is a financial institution whose status, rules and procedures expressly state its commitment to the principle of Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations". Islamic banks are working on two basic principles i.e. doing their business on profit and loss sharing principle and avoiding interest in making receipt and payment in their business transaction. The first Islamic banking experiment was observed in 1963 by an Egyptian bank “MytGhamr" but in Pakistan a full fledge Islamic banks were establish in 2003 when Meezan Bank start working as a first Islamic bank of Pakistan. Currently 7 pure Islamic banks with 482 total braches and 13 conventional bank that have Islamic window with total 202 branches working all over the country.

Islamic banking is as important invention in the banking industry because majority of Muslims are not willing to work with conventional bank as interest is prohibited in Islam and conventional bank offer interest base banking. This new banking system was more acceptable for Muslims . Due to the achievements of Islamic banks, other key international banks also started Islamic banking windows to attract new customer.

In order to satisfy your customer, a banker should know what the customers want from them. Customer satisfaction is nothing but just feelings held by customer when their needs are fulfilled as a customer. Religious perspective is also an important factor identify customer satisfaction. Previous research regarding selection of bank, shows that while selecting a bank, most of the customer’s take religious perspective as a selecting factor of any bank. A study conducted by Metawa and Almossawi (1988) found that people take two main factors into consideration while selecting a bank. 1) Bank working



on Islamic law 2) rate of return and profitability. Dasuki and Abdullah (2006) has also found religious factor as key factor in bank selection process of a customer. Previous studies such as .Rizwan et al. (2014); Ashraf (2014) also found positive effect of religious perspective on customer satisfaction and loyalty. However it is also observed that only religious perspective alone is not important for customer satisfaction. A bank working on Islamic law and having superior quality service and cooperative staff will lead to customer satisfaction and will win customer loyalty. So on the basis of above discussion we can conclude the following hypothesis.

H5: religious perspective has positive effect on customer satisfaction

H6: religious perspective has positive effect on customer loyalty

H7: Customer satisfaction mediate the relationship between religious perspective and customer loyalty

Bank image, customer satisfaction and customer loyalty: Bank image is a view which is held by customer for that particular bank. It

represents the overall assessment of an organization that comes into our mind when we hear about a particular firm or organization. It is actually peoples perceptions about firms, a positive brand image, perception of service quality that make a brand always attractive. Kotler (2001, p. 273) defined image as "the set of beliefs, ideas, and impression that a person holds regarding an object". Brand image is defined by Biel (1992) as a set of traits and associations that customers hold related to a brand name. A firm or its product/service with positive and favourable image in the mind of customer would certainly achieve market advantages over the competition and would have a better position in the industry that would increase company performance and profitability (Park, Jaworski, &MacInnis, 1986). Furthermore numerous past studies have found that positive image helps firms to make customers more loyal (e.g. Koo, 2003; Kandampully&Suhartanto, 2000). Brand image become more important when we talk about banking sector. Harwood (2002) stated that it is critical for bankers to build favourable image and to differentiate itself from other banks as every bank offers same kind of product in the industry.

Past branding studies suggested that there is positive effect of favourable brand image on customer satisfaction. Dacies &Chun (2002), there is positive association between brand image and customer satisfaction. Further some studies (Afsar et al. 2010; Patawayati et al. 2013; Rehman & Afsar 2012) have found strong and positive effect of bank image in customer loyalty. However Chun (2002) found indirect relationship between loyalty and brand image where brand image is mediated by customer satisfaction. Based on above literature we can make the following hypothesis for our studies.

H8: Bank image has positive effect on customer satisfaction

H9: Bank image has positive effect on customer loyalty

H10: Customer satisfaction mediate the relationship between bank image and customer loyalty


Research Framework: The main objective of this study is to identify the effect of service quality, religious

perspective and bank image on customer loyalty where customer satisfaction also plays its role as a mediator. Research model of the study is given below

\ Methodology: Sample and data collection:

In order to achieve the purpose of this study, a structured questionnaire was designed to collect data for further statistical testing. The target population for our research was people of twin cities i.e. Rawalpindi and Islamabad who have bank accounts either in Islamic bank or conventional bank, or conventional bank with Islamic window. The sampling technique we used in our research to collect information from people who were most appropriately available is non probabilistic method. The reason to use this technique is to gather large number of information more swiftly and also the cost is very low. The respondents participate voluntarily and it was assured their responses will be keep confidential and only will be used for this research.

Keeping 5% error margin and 95 confidence level, a total 260 sample size was selected and questionnaires were distributed. From 260 distributed questionnaires, 212 were received back and out of them 15 questionnaires were not filled properly and 206 were useable for our research. So the respondent rate is 79%. The questionnaires were distributed by hand to different universities and organization and from some users online data was collected who had access to internet.

Demographic detail of the respondents: As mention above total response of sample size was 206. Out of these major

portion consisted of males, which is 156 (76% of total sample size) and 50 respondents were female which is 24%. We divided our population into three main groups; one that is using Islamic banks. They were assignde code 1. And those who are using conventional banks with Islamic window they were assigned code 2 and the third one are those respondent who are using conventional banks they were given code 3. Majority of the responded fell in class 2 that is 79% of the total population and 33% of respondents are using Islamic banking whereas 29% are those respondent who are using conventional banks. Majority of the respondent that was 83%, were below age 30. 15% of the

Service Quality

Religious Perspective

Bank Image

Customer Satisfaction

Customer Loyalty



respondent were 30 to 40 years old and only 3% fall in the 40 to 50 years category. As majority fall below 30 years of age so most of our respondent were unmarried that were 80% of the total sample size and only 20% respondent were married persons. 47% of the participants were having college level qualification whereas 52% were having master or above master degree. 2 participants were below secondary school level. 58% of the participant were either students or were jobless. 34% of the sample were serving in different organization where 8.3% respondent were businessman and running their own businesses.

Questionnaires and scale: The designed questionnaire has been divided into six main sections The first five

sections are related to our main study which explains the effect of three independent variables i.e. service quality, religious perspective and bank image, on dependent variable which is customer loyalty while customer satisfaction is playing a mediating role in this study. The last section recognizes the demographic features of the respondents like bank name, gender, age, marital status, education and profession. First five sections of the questionnaires contain thirty five (35) items. We use five point Likert scale to measure the relationship between independent and dependent variable where 1= strongly disagree and 5 for strongly agree representing the series of opinion from strongly dissatisfied 1 to strongly satisfied 5. The language we used for our research is English as English it is taught from very beginning in Pakistani schools.

Out of these thirty five (35) items that were used in our questionnaire, scale of service quality having 19 items were adopted from SERVQUAL as suggested by Parasuraman et al. (1988). Service quality is comprised of 5 dimensions which are Tangibility, Reliability, Responsiveness, Assurance and Empathy. One sample item is “Are you satisfied with the premises of the bank? Is it visually appealing?” The scale containing 5 items of second independent variable i.e. religious perspective is adopted as suggested by Rehman (2012). One sample item is “To what extent you believe that you choose Islamic banking system because of religious reasons only? The third scale is bank image and it comprises 4 items. This scale was adopted from Rehman, (2012) and one sample item is “To what extent do you think that the Islamic bank’s reputation and image plays a key role in Islamic bank’s selection? The scale of customer satisfaction (3 items) and customer loyalty (4 items) was adopted from Mohsin et al. (2011) and one sample item from this scale is “I am satisfied with staff’s response and prompt services provided by my bank? For customer satisfaction and “I often tell positive things about my bank to other people” for customer loyalty.

Reliability: Reliability Analysis is used to examine internal consistency of the observed factors.

This analysis is measured by Cronbach’s alpha. According to Swkaran (2000) Cronbach alfa is actually a reliability measure that is used to identify the relationship of different items to one another. Above 6 scale is considered as acceptable scale for reliability analysis. In our study we have 5 different variable having 35 items. Cronbach alfa of all these variables were above 7 which means that there is strong internal reliability among the items. For 19 items of service quality the scale was observed at 0.918, for 5 items of religious perspective it was 0.849, bank image include 4 items and the reliability scale


was 0.735, for 3 items of customer satisfaction it was 0.754 and rest of 4 items belonging to customer loyalty reliability observed was 0.852.

Control variables: Bank type and qualification was considered as control variable while running

regression test. These variables were found from ANOVA as we observed P <.05 or T >2 so it suggests significant effect of these variables on independent and dependent variables. For dependent variable that is customer loyalty, bank type playing control variable role while for mediator i.e. customer satisfaction both bank type and qualification are control variables.

Results: Correlation

Table 1 show the Mean, Standard deviation, Correlation and reliability of the factors. Mean of Service quality is 3.4568 which means that on average customer are satisfied with their banks services. Mean score of Religious Perspective is 3.2777, Bank Image was 3.4260, Customer Satisfaction was 3.5469 and customer Loyalty was 3.3968. It means on average respondents response is satisfaction to all the factors.

Pearson correlation was used to find the relationship between independent variables ( Service Quality, Religious Perspective and Bank Image), mediator customer and dependent variable Customer Loyalty and Table 1 suggest us that Service Quality has significant positive relation with Customer Loyalty (r = .553, P =0.000). Similarly Religious Perspective has also significant positive relationship with Customer Loyalty (r = .289, P= 0.000).

Table 1 Means, Standard Deviations, Correlations, and Reliabilities

Mean

Std. Deviation

1 2 3 4 5 6 7 8

1. Bank Name 1.9563 .7858 --

2. Gender 1.2427 .4297 -.026 --

3. Age 1.1942 .4539 -.017 -.018 --

4. Service Quality

3.4568

.6429 -.256** .148* .020 (.918)

5. Religious Perspective 3.2777 .9116 -.257** .211** -.091 .290** (.849)

6. Bank Image 3.4284 .7710 -.176* .170* -.019 .355** .652** (.744)

7. Customer Satisfaction

3.5469

.8209 -.293** .120 -.059 .645** .353** .425**

(.754)

8. Customer Loyalty

3.3968

.8855 -.208** .050 .074 .553** .289** .382**

.514**

(.852)

Note. N = 206; alpha reliabilities are presented in parentheses **p < .01. , *p < 05.



Again, Bank Image has a significant positive relation with Customer Loyalty (r = .383, P =0.000). Similar kind of significant positive relation has also been found between Customer Satisfaction with Customer Loyalty as P = 0.000 and r = .514. Similarly significant positive correlation is also observed between independent variables i.e. Service Quality, Religious Perspective and Bank Image and Customer Satisfaction as P =0.000 for all variables. Relevant Cronbach Alfa is presented in s parentheses for each variable in the table.

Regression: In order to test the mediating role of customer satisfaction, Baron and Kenny’s

(1986) technique of mediation was followed. Baron and Kenney 1986 suggest a certain procedure that there are four requirements to mediating effect: 1) the effect of Independent variable (Service Quality, Religious Perspective and Bank Image) on dependent variable (Customer loyalty) must be significant. 2) The Independent variable should have significant effect on mediator (Customer Satisfaction). 3) The Mediator variable must have significant effect on dependent variable. 4) The Direct effect of Independent variable and dependent variable is insignificant when mediation plays its role in the regression. In simple words, when we use independent variables and mediator all together in regression model, the effect of independent variable on dependent variable become insignificant while the mediator is still significant. This method was used and regression was used to identify the significant level of all these variables. Table 2 explain the first three (3) steps of the Baron and Kenny procedure. This table 2 explain the effect of independent variable (Service Quality, Religious Perspective and Bank Image) on dependent variable (Customer Loyalty) and mediator (Customer Satisfaction) and also explains the effect mediator has on dependent variable. The first model explains the effect of customer satisfaction and service quality on customer loyalty and service quality effect on customer satisfaction. The result show that there is a strong positive effect of customer satisfaction on customer loyalty (β= .534, P< .001) and thus our hypothesis 1 is accepted. Furthermore service quality has also strong positive effect on customer loyalty (β= .737, P< .001) and thus our hypothesis 2 is also supported by this result. The service quality also has positive effect on customer satisfaction (β= .767 p<.001) and accepts our Hypothesis 3. Model 2 explain the relationship between religious perspective, customer satisfaction and customer loyalty. Result show that religious perspective has strong positive effect on customer loyalty (β= .245 p<.001) and Hypothesis 5 is also accepted on basis that this result show similarly religious perspective has a positive impact on customer satisfaction (β= .283 p<.001) and hypothesis 6 is also supported. Model 3 explain the effect of bank image on customer satisfaction and customer loyalty. Result show that bank image has strongly positive effect on customer satisfaction and customer loyalty (β= .411 p<.001 and β= .399 p<.001 respectively) thus the hypothesis 8 and 9 are also accepted on the basis these results.


Table 2

Result of Regression analysis of independent variables with customer satisfaction and customer Loyalty

Dependent Variable Independent Variable β R² ∆R²

Model 1 Bank Type (Control Variable) -.234 .043 Customer Loyalty CS .534*** .267*** .224

Customer Loyalty SQ .737*** .310*** .267

Bank Type -.296 Qualification .220 .112 Customer Satisfaction SQ .767*** .446*** .334

Model 2

Bank Type (Control Variable) -.234** .043 Customer Loyalty .245*** .103*** .059 Bank Type -.296*** Qualification .,220** .112 Customer Satisfaction RP .283*** .203 .091

Model 3 BI .445*** Bank Type (Control Variable) .- .234**

.043

Customer Loyalty BI .411 .167*** .124 Bank Type -.296***

Qualification .,220** .112 Customer Satisfaction BI .399*** .147*** .135

Note: n = 206, CL= Customer Loyalty, CS= Customer Satisfaction RP= ReligiousPerspective and BI = Bank Image, Control variables were Bank type and Qualification P < .05. **p < .01. ***p < .001.

Table 3 explain the 4th step of Baron and Kenny procedure. This table shows the results of mediation regression. Firstly we use control variable and second mediator (customer satisfaction) is given and in last step the effect of all independent variables (service quality, religious perspective and bank image) are given. In step two (2), it was observed that customer satisfaction has a strong positive effect on customer loyalty (from β= .534,



P< .001 to β= .545, P< .001). In order to check Hypothesis 4, 7 and 10 we should study step 3. In third step, results indicate that service quality has still significant positive effect on customer loyalty but due to mediating role of customer satisfaction its magnitude is decreasing (from β= .737, P< .001 β= .515, P< .001) so on the basis of these result Hypothesis 4 is supported as to that customer satisfaction partially mediate the relation between service quality and customer satisfaction. The effect of religious perspective on customer loyalty becomes insignificant (P>.05) in presence of mediation of customer satisfaction (from β= .245 p<.001 to β= .106 P>.05). So full mediation is existing and supports our hypothesis 7. In step 3 the magnitude effect of bank image on customer loyalty is decreasing (from β= .411 p<.001 to = .229 p<.001) with the existence of mediator of customer satisfaction and thus Hypothesis 10 is supported and partial mediation exists.

Table 3 Results of mediation regression Analyses

Customer Loyalty β R² ∆R²

Step 1 Bank Type -.233** Qualification .036 .044 Step 2 Control Variables .044 Customer Satisfaction .545*** .271*** .227 Step 3 Control Variables .044 Customer Satisfaction .545*** .271*** .272 Service Quality .515*** .351*** .081 Religious Perspective .106 .280* .099 Bank Image .229** .303** .003 n=206 Control Variables = Bank Type and Qualification *P < .05. **p < .01. ***p < .001. Discussion:

The purpose of our study was to identify the effect of service quality, religious perspective and bank image on customer satisfaction as well as the effect of these factor on customer loyalty. The results of this study clarify important factors that lead to customer satisfaction and customer loyalty in banking industry

The result of this study confirms that there is positive relationship between customer satisfaction and customer loyalty and customer satisfaction have significant


positive impact on customer loyalty. It explains that when the customers are satisfied they eventually convert into loyal customer and work as non-paid advertisement for the company. Past studies (Ismail, Hasnah, Ibrahim, & Isa, 2006; Da Silva & Alwi, 2006; Huat et al. (2012); Mensah, 2010; He and Song, 2009) also confirm our findings that there is significant positive relationship between customer satisfaction and customer loyalty.

Our first hypothesis was that there is significant positive relationship between service quality and customer loyalty: In this study we found that services quality has direct and indirect impact by partial mediation of customer satisfaction on customer loyalty. Customers will rebuy only when the actual services meet their expectation and they are satisfied with the services. The second hypothesis was that there is significant positive effect of service quality on customer satisfaction. This hypothesis was supported by our results. Many researcher also studied the positive effect of service quality on customer loyalty. Rousan and Mohamed 2010 in their study on hotel industry found that quality of service results in customer loyalty. Similar kind of result was found in Chen and Lee 2008 when he identified that there is significant positive relation between service quality and customer satisfaction. Other researcher like Jamal and Anatassiaduo (2007); Rizan(2010); Clottey et al. (2008) and Kheng et al. (2010) also revealed in their studied that positive relationship exist in service quality and customer loyalty. The third hypothesis was service quality having significant positive relation with customer satisfaction. Again this hypothesis is supported by our study results. Past literature also shows direct and positive relationship between service quality and customer satisfaction. Akbar and Parvez (2009); Munusamy et al. (2010); Hossain and Leo (2008); Jamal and Anatassiadou (2007) and Chen & Lee (2008) also found similar positive relationship between service quality and customer satisfaction.

The fourth hypothesis was the customer satisfaction mediates service quality and customer loyalty. In this study we found that customer satisfaction partially mediates service quality and customer loyalty and thus the result also support our hypothesis. Different past literature found that customer satisfaction mediate the relationship between customer loyalty and service quality. Ismail et al. (2006) and Khen et al. (2010) have also found partial mediation of customer satisfaction on service quality and customer loyalty. However some studies (Akbar &Parvez, 2009; Chen &Lee 2008) also found full mediation of customer satisfaction between service quality and customer loyalty.

5th and 6th hypothesis, effect of religious perspective on customer loyalty and customer satisfaction. Both of these two hypothesis were supported by our study. Previous studies also confirm our hypothesis. Rizwan et al. (2014) found positive customer attitude toward Islamic banking. Another study presented by Ashraf (2014) also found positive effect of religious perspective on customer satisfaction and loyalty. The 7th hypothesis explains the mediating role of customer satisfaction between religious perspective and customer loyalty. Various studies found that customer while choosing a bank, rely on religious perspective for their decision but literature also found that religious factor is not the only factor of customer satisfaction. Researcher found that better service quality with Islamic mode of banking will satisfy their customer and ultimately make them loyal (Echchabi, Nafiu 2012; Metawa and Almossawi, 1988; Dasuki and Abdullah, 2006).



Next hypothesis was bank image has positive effect on customer loyalty. Again this hypothesis was supported by our result. Previous literature also suggest that there is positive relation between positive image and customer loyalty. Koo, 2003; Kandampully & Suhartanto, 2000 suggest strong brand image increase customer loyalty. Hypothesis 9 explains that there is positive effect of bank image on customer satisfaction. This hypothesis was also supported by our results. Many researchers studied positive effect of bank image on customer satisfaction. Bloemer et al, (1998) urged that there is significant relationship between positive brand image and customer satisfaction in banking sector. Other studies Andreassen and Lindestad(1998); Davies et al. (2003) also found similar kind of relation. Next hypothesis was to check the relationship between bank image and customer loyalty by keep customer satisfaction as a mediator. We found partial mediation of customer satisfaction between bank image and customer loyalty which supports our hypothesis. Many past literature also enlighten this hypothesis and found mediating role of customer satisfaction between bank image and customer satisfaction. Chun (2002) found that brand image has indirect relationship with loyalty via customer satisfaction. Another study that was established by Tu, Wang and Chang stated that brand image influenced customer satisfaction and customer satisfaction ultimately effect customer loyalty .

Practical implementation and recommendation: In banking industry where there is always high competition among public and

private banks and products and services are not that much different from the products and services provided by other banks so the only way to win the customers is to follow the policy of “Customers are always right”. They should follow the customers need and provide services according to their requirements. This study will help managers of the bank to track customer satisfaction and customer loyalty. This study will help them to understand the customer preferences that lead to customer satisfaction and customer loyalty. This study explains the relationship between service quality, religious perspective, bank image, customer satisfaction and customer loyalty and reveals that these factors have strong positive correlation with each other. So manager should concentrate on these factors while making policy regarding their customer satisfaction. It was also found that strong positive relation exists between customer satisfaction and customer loyalty. Beside of current service, it must also be kept in mind that these services also meet the customer requirements. Furthermore the conventional banks should adopt Islamic banking system in order to attract more customers because of religious perspective to gain more profitability and market share.

A general perception of people about Islamic banking is that there is no difference between Islamic banking system and other conventional banking system, the only change is different name for same product and services. Therefore Islamic banking should create awareness about their products and services among the people by arranging different seminar and workshops. Similarly banks should also assure that relevant officers have sufficient Islamic banking knowledge in order to satisfy customer questions. Conventional banks should also open Islamic banking windows as many of them are already operating for example Habib Bank to attract more customers particularly in Islamic world where people hesitate to do transaction with interest base banking system.


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Country Model Iraq*

Islamic banking started in Iraq in 1993 with the establishment of Iraqi Islamic Bank for Investment and Development. At present, more than fifteen Islamic banking institutions are providing services in the country including eight full-fledged local Islamic banks and four foreign Islamic banks. Central Bank of Iraq (CBI) also allowed opening of Islamic banking windows in 2011. Islamic banking windows work as a separate department within a conventional bank and operate under guidance of an independent Shariah Advisory board of the bank.

Legal Framework for Islamic Banks in Iraq: CBI regulates both conventional and Islamic banking institutions through a single

regulatory framework and Islamic banking activities fall under framework of the Banking Law 2004. In the year 2011, CBI issued new regulations addressing issues surrounding Islamic banking institutions. These regulations specified the activities that can be performed by Islamic banking institutions. Further, these regulations also illustrate funding and dealing mechanisms regarding the purchase of foreign currencies, foreign currency exchange companies, commercial papers and stock market etc.

Shariah Board: In terms of regulations issued by CBI in 2011, each Islamic banking institution is required to establish Shariah board which is responsible for providing a Shariah view on operations of the bank in order to ensure its compliance with Shariah Law. One of the main responsibilities of Shariah Board of each bank is to suggest to General Assembly/ Board of Directors of the bank all necessary steps that need to be taken or carried out to achieve compliance with Shariah Laws. The decisions of the Shariah board are binding on the executive management of the bank.

Sources • Central Bank of Iraq website http://www.cbi.iq/ • http://www.islamicfinancenews.com (Country Analysis) • http://www.iraqdailyjournal.com • http://www.tamimi.com

* Source: State Bank of Pakistan, Quarterly Islamic Banking Bulletin Sept 2016


Book Review*

Adam Smith’s The Wealth of Nations: A Modern-day Interpretation Karen McCreadie

Adam Smith’s The Wealth of Nations: A Modern-day Interpretation by

Karen McCreadie is a short but incisive attempt to explain the relevance of economic concepts identified and explained by Adam Smith almost two and half centuries ago. Adam Smith’s “The Wealth of Nations” was the first comprehensive treatment of political economy. Karen McCreadie illustrates the timeless nature of Smith’s insights by bringing them to life through 21st century examples.

The idea of division of labour has resulted in enormous increase in productivity, especially in manufacturing industries. The idea which Adam Smith put forward from keenly observing operations in a pins making factory during the early years of industrial revolution has withstood the test of time and is still prominently visible in the productivity explosion in knowledge economies of 21st century. However, it is pertinent to point out that the idea of division of labour was discussed by Ibn-e-Khudun, a great Muslim sociologist and historian many centuries earlier than Adam Smith.

Smith’s second major idea of efficient allocative prowess of market forces also has had success against outright command economies in Western economic history. Given the pre-requisite conditions, market mechanism has proven to allocate resources much better than through government intervention. The adoption of market principles by countries like China and Russia in the 1980s and 1990s respectively vindicate Adam Smith and his fervour for market mechanism. Adam Smith writes that the baker’s bread is obtained by the society at a cheaper cost not because the baker is benevolent, but because making and selling that bread enables the baker to purchase things in which he himself is not good at producing at a lower cost.

However, the baker himself does not exist out of nowhere. His ability to bake is also not naturally existing or gifted. It requires learning and that learning of arts and skills has an opportunity cost, both explicit and implicit. The explicit cost is the cost of education which can be very high in professions like engineering and medicine. The implicit cost is the time lost in earning which is not available for wage based work. Indeed, the empirical evidence from Africa, South Asia and Latin America highlights that * Book Reviewed by Salman Ahmed Shaikh is pursuing PhD Economics at National

University of Malaysia. E-mail: [email protected]


poverty and hunger along with infant mortality results in loss of human lives and the diminishing capability to work in others who survive. What if a person does not possess any skills which the firms in the labour market demand? That is where; the role of public support programs and social support institutions becomes vital.

Adam Smith pays little emphasis on the role of ethics in economic organization. Colonization, slavery, decimation of traditional societies and native population seem to have been overlooked by the great author. What if the poor people cannot afford food even if they principally produce it from their own hard work, toil and labour? Food and Agriculture Organization estimates that food per capita availability has increased since the 1970s, but still a billion people suffer from hunger. That is where; the distributional apathy of unfettered market mechanism becomes all the more prominent. Following the idol of self-pursuit and greed in basic necessities has inevitably resulted in few countries dumping their crops as waste to keep prices high. It is striking, but perhaps inevitable that such an ethically neutral approach results in pharmaceutical companies complain about lower prices in essential medicines or the bottling companies of essential water argue for complete privatization. Does animal instincts of pleasure-pain, greed and self-interest the only driving force behind economic actions?

The under-provision of public goods, negative externality costs, over-exploitation of common property resources and increased use of environmental resources beyond their regeneration capacity are inevitable results of this uni-centric approach. The recent financial crisis and the hugely expensive bailouts from public money highlight the incentive and agency problem where greed can undermine the need for shared responsibility and socially desirable choices and outcomes.

One final point where unfettered market mechanism has come short is the rise in income and wealth inequality. According to Institute of Policy Studies, the real wealth gap in America is not between the 99 percent and the 1 percent. It is between the 0.00001 percent and everybody else. The richest 400 Americans have a combined net worth of $2.34 trillion, equal to that of the bottom 61 percent of the U.S. population, or about 194 million people. Even among the top 400, there is a great divide. The richest 20 billionaires in America have a combined net worth of $732 billion. That is more than the bottom half of the American population, or 152 million people.

Wealth inequality partly results from and is worsened by the institution of usury and no broad based wealth tax. Islamic economic framework suggests a broad based wealth levy in the form of Zakat and prohibits Riba. This ensures that wealth accumulation can only result from labour income or putting wealth as equity investments in entrepreneurial projects. This can ensure a-cyclical redistribution without putting liquidity out of equity financial investments. Hence, the religious institutions can enable to fill the ethical void towards a more equitable world and enable us to have shared prosperity.


World Economic Development Indicators Top 10 OIC Countries on Per Capita GDP

Country GDP Per Capita (US$) Qatar 93,352 Kuwait 52,198 UAE 43,049 Brunei 38,563 Saudi Arabia 25,962 Bahrain 24,695 Oman 21,929 Kazakhstan 13,172 Libya 12,029 Turkey 10,972

Bottom 10 OIC Countries on Per Capita GDP

Country GDP Per Capita (US$) Somalia 133 Niger 415 Gambia 488 Mozambique 605 Guinea-Bissau 608 Togo 610 Guinea 615 Uganda 704 Afghanistan 708 Mali 715

Source: World Bank’s World Development Indicators

Islamic Indices Indicators Islamic Indices Performance (Return Percent Per Annum) Name of Index 2010 2011 2012 2013 2014 FTSE Shariah All-World 13.10 -6.00 13.40 20.40 3.90 FTSE Shariah Developed 12.60 -4.10 13.30 23.70 4.70 FTSE Shariah Emerging 17.00 -18.60 14.20 -6.40 -3.90 FTSE SGX Asia Shariah 100 15.90 -12.40 15.40 12.60 2.10 FTSE Shariah Japan 100 -1.00 -15.40 13.50 54.80 17.60 FTSE Bursa Malaysia EMAS Shariah 21.60 5.60 15.50 16.40 -1.40 FTSE SET Shariah (Thailand) 37.30 3.30 22.10 -3.50 9.30 FTSE TWSE Taiwan Shariah 10.10 -9.20 15.00 7.00 19.50 FTSE/JSE Shariah Top 40 (South Africa) 14.20 -2.90 16.50 17.30 -7.10

Source: FTSE


Islamic Capital Market Indicators Return Metrics DJI DJIM DWEM DJIETLS W3DOW DJIDEV

Average Annual Return

Pre-Crisis (2003-2006) 10.06% 14.31% 31.38% 30.87% 13.62% 10.35%

Crisis (2007-2009) -2.86% 3.77% 20.86% 3.31% -2.21% 2.55%

Post-Crisis (2010-2015) 9.27% 6.38% -2.25% -1.52% 6.83% 7.33%

Overall (2003-2015) 6.71% 8.22% 11.94% 7.79% 6.27% 6.89%

CAGR (2003-2015) 5.58% 6.58% 5.81% 5.05% 4.41% 5.40%

S. D. (2003-2015) 14.85% 17.73% 35.56% 23.82% 18.48% 16.84%

Reward to Variability 0.45 0.46 0.34 0.33 0.34 0.41

Source: Dow Jones Legends:

• Dow Jones Industrial Average (DJI)

• Dow Jones Islamic Market Index (DJIM)

• Dow Jones Emerging Markets (DWEM)

• Dow Jones Islamic Emerging Market Index (DJIETLS)

• Dow Jones Developed Market Index (W3DOW)

• Dow Jones Islamic Developed Market Index (DJIDEV) for Islamic index.

• CAGR: Compound Annual Growth Rate.

• S.D. Standard Deviation.


Top 10 Countries with Highest Rate of Adults with Bank Accounts

Account at a Financial Institution Country

Overall Male Female Iran 92.18 97.14 87.11 United Arab Emirates 83.20 89.76 66.32 Bahrain 81.94 90.25 66.74 Malaysia 80.67 83.01 78.09 Oman 73.60 83.75 63.53 Kuwait 72.91 79.30 64.00 Saudi Arabia 69.41 75.33 61.15 Qatar 65.88 68.57 61.57 Turkey 56.51 69.00 44.28

Source: FINDEX, World Bank 2014

----------------------------- x -----------------------------

Bottom 10 Countries with Lowest Rate of Adults with Bank Accounts

Account at a Financial Institution Country Overall Male Female

Turkmenistan 1.79 2.02 1.56 Niger 3.49 4.42 2.55 Guinea 6.17 8.54 3.79 Yemen. 6.45 11.39 1.67 Chad 7.70 11.74 4.00 Somalia 7.86 9.64 6.04 Pakistan 8.71 14.21 3.02 Afghanistan 9.96 15.78 3.81 Iraq 10.97 14.57 7.44

Source: FINDEX, World Bank 2014


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