A Framework for Islamic Social Banking

Abstract

Despite recent significant economic downturns, Islamic banking (IB)—banking activity that complies with Shari’ah (or Islamic law)—remains among the fastest growing financial industries in the world. However, a recurrent criticism of IB is that notwithstanding its primary religious purpose and unique products and services, it tends to follow conventional banking in prioritising profits over its delivery of social outcomes. This is an apparent contradiction with core IB religious values of promoting social justice and serving community interests. Among other possible reforms, some critics recommend addressing this more fundamentally through institutional changes, either by internalising selected existing social banking (SB) practices or by establishing a new type of IB dedicated to social purposes, or so-called Islamic social banking (ISB). Unfortunately, no existing framework is available that would serve as a basis for these reforms and it is not clear even whether they are truly warranted. To address this, this thesis begins by examining the theoretical justification for ISB. The thesis then investigates whether IB is actually failing to deliver social outcomes as part of its core purpose. Finally, the thesis considers the prospects for ISB in Indonesia as a case study, and presents a possible banking framework for a yet-to-be-created ISB system. The first part of the thesis discusses the general development of IB and SB, including their conceptual sources, principles, products, and growth. Given that Indonesia serves as the context for assessing social outcomes in IB, the thesis first compares IB and conventional banking in Indonesia in term of structure, regulation, supervision, and performance. It then provides through a literature review the theoretical underpinnings of ISB. Employing comparative research, the thesis then compares IB and SB. The findings indicate that both types of banking institutions share similar 3P principles (Prosperity, People, and Planet) or the so-called triple bottom line (TBL) in their operations. The thesis then extends the 3P principles to incorporate an additional P (for Prophet) to reflect the ethical guidance of Islamic values. This yields quadruple bottom line (QBL) principles that the thesis proposes as a suitable framework for ISB, including a mathematical formulation to calculate QBL performance. This allows banking practitioners, regulators, and supervisors to assess the social outcomes of Islamic banks through calculating their reactive, defensive, accommodative, and proactive (RDAP) responses. The second part of the thesis comprises four related empirical analyses of ISB. The first analysis investigates whether social outcomes are a concern for IB in Indonesia. Initially, the thesis identifies key concepts for assessment indicators from four different sources, comprising the existing IB literature, the KLD Index of corporate social performance, the Sustainable Development Goals (SDGs), and the Environment Social Governance (ESG) Scorecard. The results suggest six relevant traits adequately describe IB’s broad social objectives, including religiosity, the environment, society, governance, employees, and customers. Then, using 12 Islamic commercial banks (ICB), 7 Islamic banking units (IBU), and 7 Islamic rural banks (IRB) operating in Indonesia during the period 2015–16 and employing a content analysis, the thesis reveals that social failure is evident in IRBs and half of the ICBs, but only one in the seven IBUs. The thesis concludes that social outcomes are not yet a sufficiently serious concern for IBs in Indonesia, but that social objectives and outcomes have both recently increased in importance. The second analysis investigates the prospect for the establishment of ISB in Indonesia. The thesis surveys 506 IB stakeholders across six Indonesian provinces and conducts in-depth interviews with 10 Islamic banking experts working in Indonesia. The findings reveal that 42.9% of respondents consider that IB in Indonesia is socially defensive (doing the least that is required in terms of social outcomes), while 6.9% believe that it is reactive (doing less than that required). Of the remaining respondents, 34.8% consider the social performance of IB as accommodative (doing all that is required), and 15.4% see it as proactive (doing more than is required). Most respondents (53%) suggest improvement by combining corporate social responsibility and the existing zakat–waqf system. Only a minority (7.1%) appear to be in favour of the establishment of ISB, whose main feature would be to design an alternative to collateral so that low- and middle-income customers could more readily access bank financing. The third empirical analysis uses the earlier survey data and tests the applicability of the 4Ps (Prosperity, People, Planet, and Prophet) developed in the first conceptual and theoretical part of the thesis. Multiple regression results suggest that the models created are all highly significant and well reflect the broad stakeholder perspectives on bank performance. Of the four elements, the thesis finds that stakeholders rank Prosperity first, followed by Prophet and then Planet. Case studies of two Islamic banks currently operating in Indonesia and Malaysia, Bank Muamalat Indonesia (BMI) and Bank Muamalat Malaysia Berhard (BMMB), strengthen the application of the new Prophet dimension as a way for Islamic banks to improve their social performance, particularly during periods of financial distress and in response to episodes of unethical behaviour. In the final empirical analysis, the thesis employs the same survey, but with a different method to assess whether the additional 4P dimension, namely, Prophet, can be justified. The approach adopts 31 constructs from Chapra’s corollaries of Maqasid al-Shari’ah, to be analysed using categorical principal component analysis (CATPCA). Based on the CATPCA result, the thesis confirms that the four dimensions of Prosperity, People, Planet, and Prophet adequately represent these constructs. The approach then validates 13 constructs useful for developing a QBL performance index for sustainable IB. An application to ten selected global Islamic banks reveals that only half of the sample banks are sufficiently sustainable. Overall, Islamic banks perform poorly in terms of Planet (38%) and People (41%) while doing relatively better on Prosperity (53%) and Prophet (63%). The thesis makes at least three important contributions to the existing IB literature. First, it is the first to theoretically provide and empirically test a possible framework for the future development of ISB, in either Indonesia or elsewhere. Second, the thesis also undertakes a pioneering assessment of the prospects for the establishment of ISB in Indonesia. Finally, the thesis developed a novel and practical QBL Index useful for assessing the sustainability of IB. In turn, these provide at least three main implications for industry policy and practice. First, despite the improving social outcomes of IB in Indonesia, as considered favourably by stakeholders of all kinds, it remains unimpressive. Improvements are required particularly in the areas of the environment, customer benefits, supporting disadvantaged groups, and reaching rural areas. The thesis recommends regulators promote policies and incentives that encourage existing and new Islamic banks in Indonesia to deliver social outcomes. Second, given the Prophet dimension is a central parameter in the QBL framework, the thesis encourages IB practitioners to internalise religiosity in their corporate culture, and for regulators to consider adjusting the existing performance metrics by inserting the religiosity dimension as a point of assessment. Finally, the thesis encourages regulators to provide relevant policies that respond to the QBL assessment reported in this thesis.