Journal of Islamic Banking and Finance Julyl – Sept 2016...

Journal of Islamic Banking and Finance Julyl – Sept 2016 1

2 Journal of Islamic Banking and Finance July – Sept. 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 July - Sept. 2016 No. 3 Founding Chairman Muazzam Ali (Late) Former –Vice Chairman Dar Al-Maal Al-Islami Trust, Geneva, Switzerland

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) Chairman Basheer Ahmed Chowdry Shariah Advisor Uzair Ashraf Usmani

Editor Aftab Ahmad Siddiqi

Associate Editor Seemin Shafi

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 Website: www.islamicbanking.asia

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

Professor Dr. Mohd. Ma’sum Billah IEI, King Abdul Aziz University, Kingdom of Saudi Arabia.

Dr. Rodney Wilson Emeritus Professor, INCEIF, Lorong Universiti A Malaysia/France

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

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

Dr. S. Nazim Ali, Professor and Director, Center for Islamic Economics and Finance, Hamad Bin Khalifa University, Doha, Qatar Dr. Mehboob ul Hassan Professor, Department of Economics, (CBA) King Saud University, Saudi Arabia

National 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.

Mr. Salman Ahmed Sheikh Ph.D Scholar & Research Associate National University of Malaysia

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 July - Sept. 2016 No. 3

C O N T E N T S

1. Editor’s Note -----------------------------------------------------------------------------------------05

2. Towards a Sustainable Islamic Microfinance Model in Pakistan ---------------------09 By Salman Shaikh

3. Islamic Banking and Its Implications on Human Capital Development--------------23 In Nigeria By ZakaAbdurahman & Dr. Huud Shittu

4. The Practical & Behavioral Issues of Islamic Economic System ----------------------37 By Muhammad Zeeshan Farrukh

5. Islamic Financial Services Patronizing Behavior --------------------------------------42 in Tatarstan: An Exploratory Study By Ruslan Sabirzyanov and Muhamad Abduh

6. Wider Access to Collateral-Free Financing and --------------------------------------------54 The Role of Waqf in Promoting Loss-Profit Sharing Contracts. By Mohammed Mahmoud Mantai

7. Shariah Appraisal of the Takaful Model based on ‘Tabarru’ (donation) ------------63 By Farrukh Habib & Mughees Shaukat

8. Comparison of Efficiency in Conventional and Islamic Banks Using -----------------82 Data Envelopment Analysis (DEA) By Muhamad Nadratuzzaman Hosen, Zahra Rosa Amalia and syafaat Muhari

9. Islamic Social Finance: A Sustainable Means of Alleviating Poverty-----------------94 By Akeem Kolawole Odeduntan, Tajudeen Adetokunbo Oni & Akeem Kolawole Odeduntan

10. Country Model: Tunisia -------------------------------------------------------------------105

11. Book Review: The Great Escape: Health, Wealth, and ----------------------- ----107 the Origins of Inequality

12. Islamic Capital Market Indicators --------------------------------------------------------110


Editor’s Note In Pakistan, the Islamic banking industry has shown significant progress

particularly over the last one and half decade. At present, the Islamic banking industry has acquired above 11.4 percent share in assets and 13.2 percent share in deposits of overall banking industry. The industry experts are aiming at a further 20 percent market share for Islamic banking in the overall banking industry by 2020.

On the macroeconomic front, with lower import bill due to declining oil prices, the fiscal deficit has gone down. It will help to reduce crowding out of private sector investment. Decline in inflation rate year-on-year has allowed the central bank to keep policy rates lower and this bodes well for the Islamic banking sector. China Pakistan Economic Corridor (CPEC) provides a further opportunity in times ahead to promote asset backed financing in the process of implementation and in the aftermath of this mega infrastructure investment project.

Recently, Deputy Governor, State Bank of Pakistan, Mr. Saeed Ahmad in his address at the global conference on “Islamic Finance, Banking and Business Ethics Global Conference 2016” organized by Lahore University of Management Sciences (LUMS) stated the institution of Islamic finance is aimed at promoting ethical values like prohibition of unjust practices and assisting the underprivileged. Emerging from post global financial crisis, Islamic finance has gained global attention as an equitable and relatively more sustainable form of financing. Islamic finance is therefore fast becoming part of global finance and demonstrating its potential as a competitive financial system not only in Muslim countries but also outside the Muslim world. The asset base of global Islamic finance industry reached to US$ 2 trillion and currently Islamic finance is being practiced in more than 50 countries. The geographical outreach of the Sukuk market has become more extensive and now the investor base spans from Asia, the Middle East, Africa, America and Europe.

It is promising to note the continued efforts by International standard setting bodies like Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and Islamic Financial Service Board (IFSB) to issue guiding documents/standards on ethical behavior and governance for Islamic financial institutions including Code of Ethics for Accountants and Auditors of Islamic financial institutions, Code of Ethics for Employees of Islamic financial institutions, Standards on Corporate Social Responsibility Conduct and Disclosures for Islamic Financial Institutions.

Particularly in Pakistan, the establishment of a higher level Steering Committee for Promotion of Islamic Banking in Pakistan is one of the most significant steps of the


Government in this regard. The honorable Deputy Governor noted that the Committee had representation from banking industry, Shari’ah community, regulators, ministries and industry. The committee has recently completed its tenure of two years and major achievements under this platform include commencement of Shari’ah compliant Open Market Operations, policy framework for establishment of Islamic banking subsidiaries, establishment of Centers of Excellence in Islamic Finance Education and launching of All Shares Islamic Index of Pakistan.

On the other hand, it is encouraging to know that Islamic mutual funds manage

almost quarter of the assets under management in Pakistan’s mutual fund industry. Recently, the federal government had taken an important step to promote the industry further. To incentivize listed Shari’ah compliant manufacturing companies, the federal government has introduced a 2% tax rebate for Shari’ah compliant companies through the Finance Act 2016. This will further promote Islamic banking as the banking of first choice by providing tax relief to companies that opt for Islamic financing. Going forward, it is hoped that Islamic banking and finance sector would take full advantage of these initiatives and incentives in expediting the penetration of Islamic banking and finance.

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 the article “Towards a Sustainable Islamic Microfinance Model in Pakistan” By Salman Shaikh, discusses that Islamic banking industry had achieved exemplary growth and profitability, but despite this profitability and ample liquidity, they had not focused on Microfinance. He focused the need for Islamic Microfinance as Pakistan faces rising poverty, high unemployment, high food inflation and an underserved population of 55 million poor people. He explores the two basic Microfinance models used in Islamic Microfinance in a mathematical representation, also documented the various business models and institutional structures in vogue in offering Islamic Microfinance products and services, he also proposed how the business models and operations can be standardized, cost effective and various avenues to attract more commercial investment in this sector.

Zaka Abdurahman, a student in the Department of Economic Education, the University of Jos and Dr. HuudShittu a Senior Lecturer with bias to Islamic Law and Culture in the Department of Religion and Philosophy, University of Jos, Jos Plateau State Nigeria, present their paper “Islamic Banking and Its Implications on Human Capital Development in Nigeria” in which they discuss the opportunities that Islamic Banking offers in terms of mobilizing of funds and developing human resources. However they also discuss the challenges that face Islamic banking institutions in Nigeria. The study recommends that for the approach of human capital development in Islamic banking to be comprehensive, meeting the highest standard and in close


collaboration with the industry shall thereby give Islamic banking a great opportunity to achieve its major objectives of social justice and equitable distribution of income.

In his article “The Practical & Behavioral Issues of Islamic Economic System” Muhammad Zeeshan Farrukh discusses and analyzes the possible hindrances, issues and challenges, in implementing an Islamic Economic System. He talks about the different ways both proponents and customers view the concept of Islamic finance and how these impact on the possible behavior expected from different segments of society. He further presents recommendations on how to sell the concept to different groups.

“Islamic Financial Services Patronizing Behaviour in Tatarstan: An Exploratory Study” takes an initial look at the level of acceptance for Islamic Finance in Tatarstan. The authors, Ruslan Sabirzyanov from International Islamic University Malaysia and Muhamad Abduh from Universiti Brunei Darussalam have conducted a behavioural study using confirmatory factor analysis and structural equation model with a sample size of 517 to find the awareness and variables that influence the acceptability for Islamic Finance in Tatarstan.

Mohammed Mahmoud Mantai associated with INCEIF- The Global University of Islamic Finance, Kuala Lumpur, Malaysia, in his paper “Wider Access to Collateral Free Financing and the Role of Waqf in promoting Loss-Profit Sharing Contracts”, examines the extent of access to collateral free financing and examines the role of Waqf in facilitating such financing especially in the context of micro financing.

The paper “Shariah Appraisal of the Takaful Model based on Tabarru” by Farrukh Habib & Mughees Shaukat argues that the concept of ‘Tabarru’ has been implemented while following only the letters of the Islamic law, but not the spirit. In order to support such practices, some dubious and perplexing explanations have been utilized; making the whole structure of such Takaful models questionable. This study critically examines the ‘Tabarru’ based models of Takaful. The analysis shows that the present practices of ‘Tabarru’ based Takaful models renders it more in violation of Shariah ordainments than in compliance to them. Such deviations lead to an increasing absence of risk sharing in finance which is a necessary requirement of an Islamic economic system. Therefore, it is suggested that the ‘Tabarru’ structure, as implemented today, needs to be re-examined and reformed on the basis of the concept of risk-sharing.

The paper “Comparison of Efficiency in Conventional and Islamic Banks Using Data Envelopment Analysis (DEA)” written by Muhamad Nadratuzzaman Hosen , Zahra Rosa Amalia and Syafaat Muhari, all associated with UIN Syarif Hidayatullah Jakarta, Indonesia, attempts to discuss the efficiency of Islamic Banks vis-a-vis conventional ones by comparing four of each in Indonesia during the period 2009 to 2012 and conclude that on an average Islamic banks need to catch up with their conventional counterparts in efficiency. This result is reached after much involved data analysis.

The article, “Islamic Social Finance: A Sustainable Means of Alleviating Poverty” contributed by Akeem Kolawole Odeduntan and Tajudeen Adetokunbo Oni both Chartered Accountants, affiliated with Ahmed Zakari & Co. (Chartered Accountants), Lagos, Nigeria, very comprehensively discuss the various financial and economic systems that Islam prescribes which are all aimed at creating a fair and equitable distribution of wealth and thus wellbeing of the society in general. They discuss


this in context of elimination of Riba, the use of Zakat, Sadqah, Waqf, Qard e Hasan and microfinance and how each of these can help minimize social injustices by making the people more self reliant financially. The paper adopts a qualitative research approach to examine theoretically, Islamic social finance in the perspective of communal oriented institutions. The authors conclude that Islamic social finance remains one of the viable options of restoring peace and tranquility to the world system.

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Ilorin.

“I appreciate the gesture of the Association for floating the

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and bless its members and Editorial Board.”

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Towards a Sustainable Islamic Microfinance Model in Pakistan

By Salman Ahmed Shaikh1

Abstract According to SDPI estimates, poverty rate in Pakistan has increased sharply, especially in rural areas. Some 58.7 million Pakistanis are classified as poor while Microfinance beneficiaries are only 2.8 million people. The progress and penetration of Islamic Microfinance is even more insignificant in relation to the enormous underdevelopment challenges faced by Pakistan. In this paper, we document the progress of Islamic Microfinance in Pakistan and build the case of its importance for Pakistan and for the Islamic finance industry. We also document the various business models and institutional structures used in practice for offering Islamic Microfinance products and services. We also document the regulatory environment under which Islamic Microfinance products can be offered in Pakistan. We explain the two basic models of Islamic Microfinance using a mathematical representation. The paper highlights the reasons why Islamic Microfinance in particular and Microfinance in general is not growing as rapidly as it should have given the level of underdevelopment and poverty in the country. Lastly, we propose how standardized screening and complimentary operations of NGOs and commercial IMFIs together with fiscal and monetary support can make Islamic Microfinance sustainable and commercially viable.

Keywords: Microfinance, Microcredit, Islamic Microfinance, Islamic Banking, Islamic Finance, Poverty

JEL Codes L38, I31, O10

1. Introduction Islamic banking and finance industry has achieved substantial growth on a global

scale since the dawn of the new millennium. In the middle of the financial and economic

1 Salman Ahmed Shaikh is pursuing PhD Economics at National University of Malaysia. E-mail:

[email protected]


crisis of 2007-10 and even afterwards, the Islamic banking and finance industry has witnessed significant growth in double digits.

In Pakistan, Islamic banking has achieved market share of almost 12% in the total banking industry. Currently, there are 5 full-fledged Islamic banks and at least 15 other commercial banks that operate Islamic banking windows alongside conventional banking in Pakistan. Figure 1 presents the trend in total assets, total deposits and total financing in Islamic banking in Pakistan based on quarterly data for the period 2006-2015. It can be seen that the growth is uninterrupted and more pronounced since 3QCY10. However, the gap between deposits and finance has widened since 2009. Slow growth in manufacturing sector due to security and energy crisis has partly contributed to this. That is why, the finance to deposit ratio is below 40% currently. On the other hand, stronger relative growth in deposits as compared to financing has contributed to the lower finance to deposit ratio.

Figure 1: Growth in Islamic Banking Assets, Deposits & Advances

Source: Islamic Banking Bulletin, SBP, Various Issues

Having said that, despite this unprecedented growth, none of the Islamic banks, either full-fledged or those with Islamic banking branches have ventured into Islamic Microfinance in Pakistan. This trend of events is not due to low profitability or liquidity. The lack of banking sector interest in this segment owes to cost and documentation considerations.

In this paper, we give the progress of Islamic Microfinance in Pakistan and build the case of its importance for Pakistan and for the Islamic finance industry. We also document the various business models and institutional structures used in practice for offering Islamic Microfinance products and services. We also propose how the business models and operations can be standardized so as to make the operations more cost effective and pave way for more commercial investment in this sector.

The paper proceeds as follows. In section 2, we show the current progress in Islamic Microfinance in Pakistan and the regulatory environment through which Islamic


Microfinance products can be offered in Pakistan. In section 3, we highlight the need for Islamic Microfinance in Pakistan by citing several economic indicators. In section 4, we explain the various models of Islamic Microfinance using mathematical representation. In section 5, we note reasons why Islamic Microfinance in particular and Microfinance in general is not growing as rapidly as it should have given the level of underdevelopment and poverty in the country. Lastly, in section 6, we propose how standardized screening and complimentary operations of NGOs and commercial Islamic Microfinance Institutions (IMFIs) together with fiscal and monetary support can make Islamic Microfinance sustainable and commercially viable.

2. Current State of Islamic Microfinance in Pakistan According to the State Bank of Pakistan (SBP) guidelines for setting up Islamic

Microfinance institutions, following are the possible modes of organizing Islamic Microfinance operations:

• Establishing Full-fledged Islamic Microfinance Banks (IMFBs)

o Nationwide. o Province wide. o Region wide.

• Islamic Microfinance Services by Full-fledged Islamic Banks

o Mode 1- Islamic Microfinance Counters at Existing Branches. o Mode II- Standalone Islamic Microfinance Branches & Mobile Banking. o Mode III- Establishing Independent IMFBs as Subsidiaries of Banks. o Mode IV- Developing Linkages with Islamic MFBs/MFIs.

• Islamic Microfinance Services by Conventional Banks

o Mode 1- Islamic Microfinance Counters at Existing Branches.

o Mode II- Standalone Islamic Microfinance Branches & Mobile Banking.

o Mode III- Establishing Independent IMFBs as Subsidiaries of Banks.

o Mode IV- Developing Linkages with Islamic MFBs/MFIs.

• Islamic Microfinance Services by Conventional Microfinance Banks (MFBs)

In Pakistan, the minimum capital requirement for different MFBs is as follows:

Table 1: Minimum Paid-up-Capital Requirement for MFBs Type of Institution Minimum Paid-up-Capital (in mln Rs.) Nationwide MFBs 1,000 Province wide MFBs 500 Region wide MFBs 400 District wide MFBs 300



The MFBs are also required to maintain Capital Adequacy Ratio (CAR) equivalent to at least 15% of their risk-weighted assets. Currently, there is no Islamic microfinance bank in Pakistan at the moment. Some of the more prominent organizations operating to provide Islamic micro financial services include Akhuwat, Wasil Foundation, Kashf Foundation, Naymet Trust, Muslim Aid Pakistan, Islamic Relief Pakistan, Kawish Welfare Trust and Esaar Foundation.

One of the recent success stories has been the Qard-e-Hasan model of Akhuwat. This institution with humble setup and uncomplicated procedures had disbursed Rs 20 billion worth of loans by October 2015 without interest with 99% recovery rate. Out of total beneficiaries of 1.1 million people, 42% had been female clients.

Kashf Foundation is another organization with a sizable outreach. The microcredit loan portfolio stands at Rs 3.6 billion ($34.6 million) and additional Murabaha portfolio of Rs 56 million ($0.53 million) as at December 31, 2004 with a healthy return on portfolio with Rs 1.38 billion ($13.3 million) coming in service charges on micro-credit loan portfolio and Rs 6.7 million($65,000) coming from profit on Murabaha.

Wasil is another microfinance institution which provides loans using Islamic modes of financing which enable it to generate profits on sale and lease of assets. In the reported statistics for 2010, the gross loan portfolio stood at Rs 210 million ($2.1 million) with a 91% recovery rate. Wasil provides a range of business development services delivered through the platform of Micro Enterprises Support Services and Advocacy Cell (MESSAC). The programs include vision and skills enhancement sessions, value addition to products and processes and redesigning service outlets and branding.

Naymet Trust provides loans using Qard-e-Hasan and Murabaha with respective shares of 30% and 70% of each in the financing portfolio. The total assets of the trust at June 30, 2015 stood at Rs 11.3 million ($108,650). Total credit portfolio was recorded at Rs 9.9 million ($96,000) with Murabaha portfolio of Rs 2.95 million ($28,365) and Qard-e-Hasan portfolio of Rs 6.96 million ($67,000).

Islamic Relief is an example of an incorporated microfinance institution in Pakistan operating since 1992 with presence in all four provinces of Pakistan, especially in northern areas of Pakistan. Their microcredit portfolio was clocked at Rs 38 million ($0.36 million) as at December 31, 2014. The institution has helped some 11 million families over its 25 year journey in Pakistan with various programs including rehabilitation of internally displaced persons, disaster risk reduction, climate change adaptation, water and sanitation, food security and health programs.

3. Need for Islamic Microfinance in Pakistan Half of global poverty resides in the Muslim world while the Muslim population is

24% of the total global population. Islamic Microfinance constitutes just 1% of the total Islamic financing. Microfinance reach is low because of voluntary and involuntary financial exclusion. Involuntary exclusion is due to supply side constraints like lack of collateral and high cost of operations. Voluntary exclusion is due to religious reasons. Most Muslims do not opt for interest based modes of financing.

In Pakistan, Naveed & Ali (2012) in a most recent study conclude that as many as 58.7 million people in Pakistan are living in multidimensional poverty with 46% of the rural population and 18% of the urban households falling below the poverty line.


As compared to the roughly 50 million poor people estimated by the poverty

headcount ratio in Pakistan, the number of people benefitting from microfinance is only as much as 3 million. Table 2 presents the outreach statistics from the four provinces of Pakistan. It is disturbing to note that penetration ratio is the lowest in two of the most impoverished provinces of Pakistan, namely Balochistan and KPK.

Table 2: Microfinance Outreach – Province wise Key Indicators - Province wise Sindh Punjab Balochistan KPK Offices – Fixed 729 1,832 17 95 Offices – Mobile 4 7 - 4 Active Borrowers 754,724 2,677,467 5,303 103,738 Potential Microfinance Market 6,357,795 15,233,924 1,656,762 4,083,817 Penetration Rate (%) 11.9% 17.6% 0.3% 2.5%

Source: Pakistan Microfinance Network

In Pakistan, inflation had remained in double digits during the last decade and real incomes for people in bottom pyramid had not increased. To make the task more challenging, in-migration rate in small number of mega cities is as much as 2% per annum. Almost all in-migrants become part of the urban labor force right after migration. This together with natural rate of increase in population brings 4% additional labor force in urban areas seeking employment. This pressure had resulted in unemployment rate in urban areas exceeding the unemployment rate in rural areas as can be seen in Figure 2.

Figure 2: Unemployment Rate in Rural & Urban Areas

0

2

4

6

8

10

12

2005 2006 2007 2008 2009 2010 2011 2012 2013

Unemployment (Rural) Unemployment (Urban)

Source: Economic Survey of Pakistan 2012-13 Hence, Islamic banks and conventional banks with Islamic banking branches in

urban areas can use their existing branch network to cater to Microfinance needs in urban areas. Documentation, collateral and contract enforcement problems are also less challenging in urban areas as compared to the rural areas.



Nevertheless, rural areas also require attention since 46% of the rural population is living below the poverty line. High labor force participation rate and low unemployment rate in rural areas had still not been able to reduce rural poverty. This phenomenon hints at more exploitative labor management practices in rural areas. Islamic Microfinance by increasing the availability of income generating assets in the hands of the rural poor can contribute in generating self-employment and reducing rural poverty.

Figure 3: Labor Force Participation Rate in Rural & Urban Areas

26272829303132333435

2005 2006 2007 2008 2009 2010 2011 2012 2013

LF Participation (Rural) LF Participation (Urban)

Source: Economic Survey of Pakistan 2012-13

Furthermore, Islamic finance industry itself is in search of a distinctive identity in terms of its achievement and contribution rather than highlighting only the differences in contract mechanics alone. El-Gamal (2008) criticizes that currently, the emphasis in Islamic finance is on contract mechanics and certification of Islamicity by “Shari'ah Supervisory Boards”. Ismail (2011) also states that recent growth experience and product innovation directed towards coming up with more sophisticated products using debt based structure exhibits that growth has taken more precedence over Shari’ah compliance in letter and spirit. Hence, venturing into Islamic Microfinance can also provide more legitimacy and support to the Islamic finance industry and bear fruit to its search for models to realize egalitarian distribution of income.

4. Islamic Microfinance Business Models Obaidullah (2008) explains that there are two broad categories of Islamic

Microfinance models that are globally used:

• Charity-Based and Not-For-Profit Models

• Market-Based and For-Profit Models

Charity-Based and Not-For-Profit Modes includes Qarz-e-Hasan, Waqf and Zakah funds for providing non-compensatory loans and non-repayable grants. Market-Based and For-Profit Modes include Micro-Credit using Murabaha, Micro-Leasing using Ijarah


and Micro-Equity or a Composite Model of Microfinance which is a hybrid of these modes.

Equity based modes are usually not used because of agency problems. Bacha (1997) highlights serious agency problems in Mudarabah and argues that it lacks the bonding effect of debt financing and can induce perverse incentives. Using scenario analysis, he shows that for a ‘borrower’ faced with the alternative of using Mudarabah, debt or equity financing; Mudarabah would be the best in a risk-return framework. For a financier faced with the same three alternatives however, Mudarabah financing would be the worst. Likewise, Khalil et al. (2002), Dar & Presley (2000), Warde (1999) and Rosly & Zaini (2008) also highlight the structurally chronic agency problem in Mudarabah. State Bank of Pakistan in its report ‘Financial Stability Review for 2007-08’ comments on the issue in following words:

“In fact the agency problem is one of the major factors for the reluctance on the part of banks to undertake equity based modes of financing, as it gives entrepreneurs the incentive to understate profits.” (p. 7, Chapter 8).

4.1. For Profit Business Models The basic structure of Islamic Microfinance banking can be explained

mathematically as follows. First, an Islamic Microfinance bank creates an asset pool (AP) which consists of bank’s equity (E) and deposits (D). Deposits include two further classifications, i.e. remunerative deposits (RD) and non-remunerative deposits (NRD). RDs are mobilized using partnership mode ‘Mudarabah’ with bank’s shareholders and depositors as partners. Profit sharing ratio is agreed at the start of this partnership. NRDs are mobilized using Qarz (non-compensatory loan). Mathematically, we have:

AP = E + RD + NRD ..... (i) This pool of assets is used to provide asset backed financing (ABF). In an Islamic

Microfinance banking model:

AP = ABF ..... (ii) ABF consists of various financing assets based on different underlying financing

contracts, i.e. Ijarah, Diminishing Musharakah, Murabaha, Istisna etc. Islamic bank does not lend money. It provides asset backed financing in which the asset is owned by the bank. These financing modes can be categorized as lease based financing (LBF) or credit sale based financing (CSBF). Hence, (ii) can also be written as:

AP = ABF = LBF + CSBF ..... (iii)

Income stream is generated either through profit on credit sale or rent for the use of asset. Hence, income (I) comes in the form of rent (R) or profit on sale (P).

I = R + P ..... (iv)

If R is some proportion of LBF and P is some proportion of CSBF, then (iv) can also be written as:

I = α LBF + β CSBF ..... (v)



Islamic banks use the same interbank benchmark rate (KIBOR) for pricing assets in credit sale for profit determination and computing rentals necessary to amortize the cost of asset during the lease period. We can assume the average rental rate or profit rate to be same except for differences in term premia and counterparty risk premia in customized financing assets.

I = r x (LBF + CSBF) ..... (vi)

Where ‘r’ is average rental and profit rate. Replacing AP for (LBF + CSBF) in (vi), we can see that income is distributed among the contributors in pool, including bank’s shareholders and depositors. To achieve spreads for financial intermediation function, profit sharing is done between bank and depositors as per the pre-agreed profit sharing ratio.

I = PSRRD I + PSRB I ..... (vi)

Where, I = IRD + IB. IRD represents income share of depositors and IB represents income share of the bank. In a non-depository Islamic Microfinance institution, the asset pool (AP) will comprise of bank’s equity only.

4.2. Not for Profit Business Models The basic structure of not-for-profit Microfinance model can be explained

mathematically as follows. First, an Islamic Microfinance institution creates an asset pool (AP) which consists of bank’s equity (E) and donations (D). Donations include Zakat funds, voluntary charity payments by individuals and institutions. It may also include aid and grants provided by government or other donors. Mathematically, we have:

AP = E + D ..... (i)

This pool of assets is used to provide Qarz-e-Hasan (Q). In this model:

AP = Q ..... (ii)

In subsequent periods, the fee income (I) net of expenses is again reinvested in asset pool from which more non-compensatory loans (Q) are provided. In some institutions like Akhuwat, the beneficiaries also become donors later and hence enhance the asset pool (AP) which makes the model sustainable from the supply side.

5. Issues in Commercial Viability of Islamic Microfinance

5.1. Lack of Collateral Most poor people do not own much valuable fixed assets. Hence, they are unable to

furnish collateral and hence remain underserved by the commercial banks. Even the assets they own like land, livestock or furniture are not admissible as collateral by the commercial banks.

Islamic Microfinance institutions providing asset backed financing have this in-built cushion that all their financing activities are real asset backed. For some cases, hypothecation of client’s assets can be used for collateral besides the personal and third party guarantee. However, collateral is not much of an issue with recovery rates of as high as 99%. Komi & Croson (2013) also find significantly higher compliance rates for


the Islamic-compliant contracts (profit-sharing and joint venture) than for the traditional contract (interest-based). Especially in rural areas, poor villagers have limited capacity to enter in corruption. They can hardly migrate abroad. Poor villagers are members of a family system and people have closer relations with other families in the villages.

5.2. High Cost of Operations Commercial banks look for serving bigger clients by offering large credit lines on

long term basis to reduce cost per each fresh loan. In Microfinance, the fixed cost of administering a small loan is usually high.

Islamic banks can economize on their operations by using their existing branches and sub-branches as well as the existing staff. Since banks currently employ human resource usually on permanent basis for branch operations, the additional work can still be delegated without much additional human resource hiring. For Qarz-e-Hasan, the Islamic banks can forgo the service charge or substantially reduce it if the client repays the loan or installment due by coming to the branch office himself.

5.3. Incompatible Monetary & Fiscal Policies What further discourages the commercial banks to not venture in Microfinance is

the tendency for government of Pakistan to keep large fiscal deficit and heavy reliance on indirect taxes to fill exchequer. High fiscal deficit means that government crowds out private sector borrowers and finance its deficit at high domestic interest rates. Domestic interest rates have to be kept higher by the central bank to control inflation fueled by indirect taxes, high negative trade balance, currency depreciation and monetization of public debt. Hence, when better yields are offered to commercial banks on the purchase of sovereign securities, the high-risk high-return based Microfinance remains much less of an attraction.

6. Towards a Standardized Cost Effective IMF Model In this section, we discuss how commercial viability of Microfinance can be

ensured through standardized processes.

6.1. Standardized Client Screening Recently, there have been attempts by the government to create profile of poor

people by identifying and collecting information on their demographics for various government sponsored welfare programs. Microfinance institutions can benefit from such expensive and time taking exercise by not having to reinvent the wheel. In Table 3, we present a brief, but a comprehensive survey form which can be filled for each client to ensure client screening before judging whether the client is eligible for Microfinance or not.

Table 3: Client Screening Form

Demographic Information Response

Age (in years)

Gender o Male.

o Female.



Household Size (in nos.)

Number of Dependents (in nos.)

Earning Members in Family (in nos.)

Income / Wealth Related Information

Household Monthly Income (in Rs.)

Liquid Assets Historical Price Market Value

- Cash in Hand

- Savings Funds (Bisee)

- Other Receivables

- Gold Jewelry

- Other Jewelry

- Other Liquid Assets

Fixed Assets Historical Price Market Value

- TV

- Fridge

- Furniture

- Motorcycle

- Mobile Phone

- Other Fixed Assets

Expenditure Details

Utility Bills

- Electricity (in Rs.)

- Gas (in Rs.)

- Telephone (in Rs.)

Size of Dwelling (in rooms)

Nature of Dwelling

o Cemented.

o Bricks.

o Tin / Wood.

Income Earning Assets Owned (in nos.) 6.2. Matching Need with Income Earning Assets

In Table 3, there is one field which asks about how many income generating assets the client possesses. If the client possesses existing income generating assets, then, the


client can be given Qarz-e-Hasan for meeting variable costs like 3 months fuel cost for electricity, petrol, gas and other overheads. If the client does not own an existing income generating asset, then, the client can be given asset backed financing. In Table 4, we present a tentative list of income generating assets that the client can use to choose the asset himself for which financing will be provided by the Islamic Microfinance institutions.

Table 4: List of Income Generating Assets Category A (Rs 1,000 – 20,000) Category B (Rs 20,000 – 50,000)

Juicer Motorcycle Iron Copier

Sewing Machine Oven Grocery / Fruit Carrier Livestock

Donkey Cart Merchandise Inventory Drilling Machine Construction Tools

Personal Computer Gas Stove With Cart for Popcorns Stove Construction of Road-Side Cabin

Potato Fries Machine Partial Financing for CNG Rickshaw Coal Run Stove on Cart Blender / Chopping Machine

The credit disbursement criteria can be made standardized as well by using

following screening and disbursement methodology.

Provide financing if:

• Client does not own an income generating asset in category B, and

• Household size to dwelling size ratio is less than unity, and

• Sum of household income and one sixth of value of aggregate liquid assets is less than the product of basic income required per person times household size, and

• Value of aggregate liquid assets is less than Rs 20,000, and

• Value of aggregate fixed assets is less than Rs 50,000, and

• Sum of value of utility bills paid is less than Rs 2,500 per month on average.

Provide non-compensatory loan if:

• Household size to dwelling size ratio is less than unity, and

• Sum of household income and one sixth of value of aggregate liquid assets is less than the product of basic income required per person times household size, and

• Value of aggregate liquid assets is less than Rs 5,000, and

• Value of aggregate fixed assets is less than Rs 20,000, and

• Sum of value of utility bills paid is less than Rs 2,500 per month on average.



The government can support the operations by levying low or no sales tax on these income generating assets. Islamic Microfinance institutions can also look into the possibility of bulk discounts from manufacturer / vendor of these income generating assets.

6.3. Skills Training Through NGO / Waqf Obaidullah (2008) explains the difference between livelihood enterprise programs

and growth oriented programs. The former only offer credit facility, while the later also provide training, insurance and skills enhancement facilities. Rashidah & Faisal (2013) also highlight that provision of education and training, better coordination and networking and technical assistance through Waqf and Zakah funds is necessary for the effectiveness and sustainability of Islamic Microfinance.

The NGO or Waqf model can be used to fund the establishment of training and business support centers. The recurring costs can be managed by taking a fee in terms of requiring the trained person to further train a fixed number of clients. Hence, no monetary fee will be charged for training facilities, but, the person provided with training shall further train a fixed number of other people so that the model becomes financially sustainable and maximum leverage can be obtained from the funds that are used to establish these centers and training the first few batches. The list below mentions the priority segments for which training can be provided.

• Carpentry

• Welding

• Stitching

• Dying

• Cooking

• Office Automation

• Electrician

• Mechanic

• Electronics Repairing

• Beautician & Personal Grooming Services

• Driving

• Flower Making

These training centers will compliment the financing functions of Microfinance institutions as the people with required human capital are expected to be more productive and hence earn income levels that can cover the cost of financing and leave some surplus for the client.

6.4. Priority Finance to Projects with Employment Generation Capacity There are certain businesses that are more labor intensive than others. Organizing

such businesses as a micro enterprise has the benefit of obtaining technical and financial economies of scale. Such businesses can be financed at a cheaper cost provided that they


hire at least 70 to 100 new laborers. The subsidy in the cost of finance can be provided through the central bank. SBP is already providing export refinance facility and Islamic banks had also developed a Shari’ah compliant alternative to offer such schemes as well. Hence, the same structure and mechanism can be utilized for financing the priority sectors with a relatively more labor intensive nature. Below, we list such sectors in the manufacturing, agricultural and services category.

• Services Category o Furniture Making o House Maintenance o Catering

• Manufacturing o Textile o Light engineering

• Agriculture o Dairy Farms o Fruit Gardens o Fish Farms o Poultry Farms

Conclusion

In this paper, we explored that Islamic banking industry had achieved exemplary growth and profitability, but despite this profitability and ample liquidity, they had not focused on Microfinance. We documented the need for Islamic Microfinance as Pakistan faces rising poverty, high unemployment, high food inflation and an underserved population of 55 million poor people. We explored the two basic Microfinance models used in Islamic Microfinance in a mathematical representation. We also documented the various business models and institutional structures in vogue in offering Islamic Microfinance products and services. We also proposed how the business models and operations can be standardized so as to make the operations more cost effective and pave way for more commercial investment in this sector.

References Abdul-Rehman, R. & Dean, F. (2013). “Challenges and Solutions in Islamic

Microfinance”, Humanomics, 29(4), pp. 293 – 306.

Bacha, I. O. (1997). “Adopting Mudarabah Financing to Contemporary Realities: A Proposed Financing Structure”, The Journal Of Accounting, Commerce & Finance, 1(1), pp. 26 – 54.

Dar, H. A. & Presley, J. R. (2000). “Lack of Profit Loss Sharing in Islamic Banking: Management and Control Imbalances”, International Journal of Islamic Financial Services, 2(2), pp. 1 – 9.



El-Gamal, M. A. (2008). “Islamic Finance: Law, Economics & Practice”, Cambridge: United Kingdom.

Ismail, A. G. (2011). “The Theory of Islamic Banking: Look Back to Original Idea”, Journal of Islamic Economics, Banking & Finance, 7(3), pp. 9 – 22.

Khalil, A. F. A.; Rickwood, C. & Murinde, V. (2002). “Evidence on Agency-Contractual Problems in Mudarabah Financing Operations by Islamic Banks”. Islamic Banking and Finance: New Perspectives on Profit Sharing and Risk, 57.

Komi, M. E. & Croson, R. (2013). “Experiments in Islamic Microfinance”, Journal of Economic Behavior & Organization, 95, pp. 252 – 269.

Naveed, A. & Ali, N. (2012). “Clustered Deprivation - District Profile of Poverty in Pakistan”, Social Policy Development Institute.

Obaidullah, M. (2008). “Role of Microfinance in Poverty Alleviation”, Jeddah: IRTI

Obaidullah, M. (2008). “Introduction to Islamic Microfinance”. New Delhi: IBF Net.

Rosly, S. A. & Zaini, M. A. M. (2008). “Risk-return Analysis of Islamic banks’ Investment Deposits and Shareholders’ Fund, Managerial Finance, 34(10), pp. 695 – 707.

State Bank of Pakistan (2008). “Financial Stability Review 2007 – 08”, Karachi.

State Bank of Pakistan (2007). “Guidelines for Islamic Microfinance Business by Financial Institutions”, Karachi.

Warde, I. (1999). “Islamic Finance in Global Economy”, Edinburgh: Edinburgh University Press.


Islamic Banking and Its Implications on Human Capital Development in Nigeria

By ZakaAbdurahman & HuudShittu Ph.D

∗

Abstract Recently, the Central Bank of Nigeria embarked on provisions for the proper establishment and operation of Islamic (Interest free) banking. This paper examines the viability of promoting Islamic banking in Nigeria and its implications on human capital development. This paper reveals various opportunities for Nigeria in promoting Islamic banking such as mobilization of funds, means of achieving financial inclusion, exchange of expertise, employment generation, promotion of quality services and healthy competition. This paper highlights the challenges that could hinder the development of the Islamic banking industry which include lack of awareness by the general public, lack of a Supervisory council on Shari’ah (Islamic Law), shortage of qualified manpower, prohibitions of interest (Riba) and Usury (Gharar) in all financial dealings among others. To ameliorate these challenges, the study recommends the effective regulation and supervision of Islamic banks, massive sensitization campaign and review of the existing company and banking laws. The paper concludes that the successful development of the Islamic banking industry in Nigeria will depend to a large extent on the size and quality of its human capital. In light of this, the study recommends that the approach of human capital development in Islamic banking to be comprehensive, meeting the highest standard and in close collaboration with the industry shall thereby give Islamic banking a great opportunity to achieve its major objectives of social justice and distribution of income. From the forgoing, it will be established that developing Islamic banking in Nigeria will have positive multiplier effects on both the financial sector and the economy as a whole.

Key word: Islamic Banking, Human Capital Development, Riba, Wadi’ah, Takafu, Gharar.

∗ Author: ZakaAbdurahman is a student in the Department of Economic Education, the

University of Jos. Dr. HuudShittu is a Senior Lecturer with bias to Islamic Law and Culture in the Department of Religion and Philosophy, University of Jos, Jos Plateau State Nigeria.


Introduction The role and functions of the banking system in a contemporary economy is of

great significance to the development process. History has shown that the banking system is among the most imperative aspect of any economy which aspires to thrive. A functioning banking system helps to create a more successful and efficient society. Banks facilitate the transfer of resources from those with excess to those who require resources; hence the financial system is often considered as the heart of every prosperous economy. In light of this, the emergence of Islamic banking in various parts of the world either as the mainstream banking or as an optional banking practice, is of great significance to individual economies and the global economy as a whole (Pan African capital, 2011; Daud, Yossof&Abideen, 2011).

The Central Bank Nigeria (CBN) recently enacted new provisions for the proper establishment and operation of Islamic banking through the Non-Interest Financial institutions (NIFI) framework. The newly released framework of Non-Interest Financial Institutions(Islamic banking) has added a lot of prospect and dynamism to the Islamic banking project in the country. Nevertheless the likely challenges that could hinder the development of the industry include lack of awareness by the general public, lack of an Islamic Law supervisory council, shortage of qualified manpower among others. Human capital is a key to the success of any organization, hence building an appropriate balance and mass of human resource and providing an enabling environment for all individuals to be fully engaged and contributing to the goals of an organization is very important. This has formed the backbone for the research into the viability of promoting Islamic banking in Nigeria and its implication on human capital development.

Islamic Banking Islamic banking is financial intermediation based on Islamic law; it is guided and

codified within the frame of Islamic law called Fiqhal-Muamalat (Islamic rules on transactions) by the Qur’an, the Sunnah (teachings and practices of Prophet Muhammad pbuh) including other secondary sources of Islamic law such as opinions collectively agreed among the scholars (Ijma), Analogy (Qiyas) and personal reasoning (Ijtihad).

According to Saidur-Rahman as cited in Jaiz (2011), Islamic banking has been defined in a number of ways. The General Secretariat of the Organization of Islamic Conference (OIC) in its foreign ministers conference at Senegal in 1978 approved the definition of an Islamic bank as a financial institution whose statues, rules and procedures expressly state its commitment to the principles of Islamic law and to the proscription of payment and receipt of interest on any of its operations.

Viewing the concept from an Islamic economy perspective and the role to be played by an Islamic financing institution, Shehta cited in Jaiz (2011) explains that it is imperative for an Islamic bank to incorporate in its functions and practices, commercial investment and social activities, as an institution which are aimed at promoting the civilized mission of an Islamic Economy. According to Islamic Banking Act (1983) cited in Jaiz (2011) of Malaysia, an Islamic Bank is a company which carries out Islamic banking business. Islamic banking business here means banking business whose aims and operations do not involve any element which is not approved by Islam.


Considering information in Wikipedia (2011), it defines Islamic banking as any

banking activity that is consistent with the principles of Islamic law and its practical application through the development of Islamic economics. Based on these definitions of Islamic banking, this paper concludes that for a system to be called an Islamic bank, it must adhere to the principles of Islamic transactions in which Profit and Loss Sharing (PLS) is a major feature, with the avoidance of Usury (Riba) and risky or ambiguous sale (Gharar) or investing in goods and services that are considered contrary to Islamic principles aimed at ensuring justice and equity in the economy.

Human Capital Development Examined As the global economy shifts towards more knowledge based sectors, skills and

human capital development has become a central issue for policy makers and practitioners engaged in economic development at the national and regional levels. Human capital is used to describe the number of persons who have skills, education and experience in an economy. It is defined as the knowledge, skills, attitudes, physical and managerial effort required to manipulate capital, technology and land among other things, to produce goods and services for human consumption (Adelakun&Babalola, 2011).

Martinez (2012) explains that the concept of Human Capital can be interpreted in many ways. One of them could be looking at the individual as an asset, a resources that belongs to the economic unit and from which can be demanded all its capacity and commitment. Human Capital can be seen as a treasure that an economic unit has available with respect to the qualifications of individuals. Therefore Human Capital represents the capabilities and skills. In corroboration, Garba (2008) explains Human Capital as the total stock of human resource produce by an economic entity, from which it can pull skills (know-how), knowledge, entrepreneurial and innovative capacities required to produce, distribute and utilize ideas, goods and services to generate growth and development.

Jhingan (2010) notes that the process of investing in Human Capital is called Human Capital Development; he defines Human Capital Development as the process through which a country acquires and increases the number of persons who have the skills, education and experience which are critical for its economic and political development. He notes that in its wider sense, investment in Human Capital means expenditure on health, education and social services in general; and in its narrower sense, it implies expenditure on education and training.

The Principles of Islamic Banking In view of the fact that Islamic banking operates based on Islamic law, it is argued

by the proponents of Islamic banking that in today’s world, the economic system that is based on interest has resulted in concentrating wealth in the hands of a selected few, creating monopolies and further widening the gap between the affluent and the poor. Islamic finance operates in compliance with the Islamic law. In contrast to the modern western principles and philosophies, Islam encourages circulation of wealth and considers its role as vital to an economy (Nasim 2004). Usmani cited in Nasim (2004) notes that just as clotting of blood paralyzes the human body so does concentration of wealth paralyze the economy. The fact that the ten richest men in the world today have more wealth than the forty-eight poorest countries of the world is used by the supporters of Islamic banking as a testament to the fact that the current economical setup is unjust

Islamic Banking and Its Implications on Human Capital Development


and has failed to distribute wealth proportionately, thus leading to the downfall of humanity today. Hence Islamic banking has its principles which stand apart from the traditional banking system and these principles are derived from the axiom of social justice.

Dogarawa (2011) explains that the system which is founded based on the principles of Shari’ah absolutely prohibits receipts or payment of any predetermined, guaranteed rate of return thereby closing the gate to the concepts of interest (Riba) and Usury (Gharar) in all financial dealings. It also prohibits the use of debt-based instruments and reprehends speculative behaviour in business. It further promotes risk sharing, encourages entrepreneurship and insists on the sanctity of contracts. Summarily, the unique features represent the basic principles of Islamic banking. Other principles of Islamic banking include the exclusion of financing and dealing in transaction which are deemed to be sinful and socially irresponsible such as gambling and alcohol, assassination and prostitution; avoiding financial transactions that are exploitive in nature; encouraging investment that adds to social value; the provision of Islamic insurance and the introduction of Zakah (alms giving). In order to understand the reason behind the prohibition of interest in Islam, there is need to understand the concept of Riba (Interest or Usury) in the Islamic economy.

Riba’ Usury Linguistically ‘Riba means ‘increase’ or growth. Riba is an Arabic word which

literally means to increase, or ‘growth’, to rise’ or to ‘become lofty’. According to Islamic jurisprudence, Riba technically refers to the ‘premium’ that must be paid by the borrower to the lender along with a principal amount as a condition for the loan or for an extension on its maturity (Jaiz 2011). Riba (interest or Usury) may be defined as any excess paid or received over and above the principal, as condition of loan for which no recompense or exchange value is paid or received which tends to increase with the passage of time and is not related with business result. Riba is traditionally viewed as predetermined, fixed and the related excess over and above the principal of the loan, the Qur’an (The Islamic holy book) prohibits interest (Riba) in several different contexts and this prohibition arises out of an Islamic concept of money as nothing more than a means of exchange. Money has no value in itself and cannot be allowed to give rise to more money; it cannot accrue any return (i.e. interest). The prohibition against Riba is a corollary of the prohibition against hoarding, or an excess accumulation of personal riches. Islam is not anti-commerce (the prophet Muhammad was a merchant). Trade and financial gain are lawful, but excessive profiteering is immoral. Neither goods nor money should be hoarded. It must be noted that Islamic Economics views interest and profit separately. Labour and effort, including that of merchants and entrepreneurs, is the creator of value and profit from trade are not unlawful. Profit is distinctive from Interest (Riba). Profit includes a return on financial investment, but the rate of return is neither fixed nor predetermined and carries with it risk. Hence, Islam sees Riba as simply a special case of unjustified enrichment or appropriating for one’s own use (Dogarawa, 2011; Jaiz, 2011; Nasim, 2004).

According to SaidurRahman cited in Jaiz (2012) the rationale behind the prohibition of Riba (interest) in Islamic economics are stated below:


1. Islamic Law rejects interest because it is the root of many socio-economic

evils;

2. It is injustice to receive only the benefit but not to share any loss for deploying capital in any venture; it is unfair if the borrower has to pay fixed interest even though he might have incurred losses. This, Islamic law views it as an injustice to the society.

3. Interest is considered as the cost of production; price of goods and service in the market are adjusted to reflect the cost of interest, hence consumers are affected.

4. Interest rate has a negative effect on investment; high rate of interest discourages investment and consequently brings about low production and income.

5. Interest creates inequalities in income; in an interest based system, the industrialist borrows money from banks and financial institution and make large profit but only give a small amount to the depositors. This leads to concentration of wealth among a few people in the society.

Islamic Banking and Human Capital Development in Nigeria Education and health are factors that enhance human capital development in every

country, therefore the importance of investing on education and health cannot be over emphasized and it is well appreciated and understood in an economy that aspires to attain sustainable growth. Any country that does not pay special attention to human resource development has invested in failure and will certainly collapse in short time. In other words, any country that wants to develop should not ignore the quality of its human resource. Indeed, the importance of a prime sector such as education has been stressed in Nigeria since the early sixties when the country got independence. Following the submission of the Ashby report in September 1960, economists observed that the development and utilization of human capital is important in a nation’s economic growth. It has been noted however, that the illiteracy rate in Nigeria is high and many workers are unskilled, it leads to their low productivity, hence capacity building still remains the greater challenge facing Nigeria in this millennium (Owolabi&Okwu, 2010).The National Policy on Education (NPE, 1998) enunciates the importance of Higher education in national development in Nigeria to include:

i. Contribute to national development through higher-level manpower training.

ii. Develop and inculcated proper values for the survival of the individual and the society.

iii. Develop individual intellectual capacity to understand and appreciate their local and external environments.

iv. Acquire both physical and intellectual skills, which will enable individuals to be self-reliant and useful members of the society.

v. Promote and encourage scholarship and community service.

vi. Forge and cement national unity.

vii. Promote national and international understanding and interaction.



Lawanson (2009) points out that these set goals are expected to be achieved by tertiary institutions through teaching, research and development, sustained staff development programmes, generation and dissemination of knowledge and a variety of modes and programmes.

The financial services industry is highly dynamic, rapidly changing and challenging environment, hence talent development for the financial services industry has become an even more important agenda to ensure that its growth and development is supported by the necessary skills and capabilities. This is particularly important for Islamic banking given that it is brand new venture in Nigeria is relatively young compared to the conventional banking system in the global economy. The recent global financial crisis has highlighted the importance that the growth of the financial sector should correspond with the growth of the economy, and the risk management as well as governance practices should be strengthened to ensure its stability and sustainability. Human capital development remains a key to Islamic banking growth at all levels and nations. Contributions by training and research institutions including private training centers are important to the development of professionals and expertise in Islamic finance (Aziz, 2011).

The role Islamic banks will play on human capital development in Nigeria is multifaceted; the Islamic banking industry has created job opportunities for human capital in Nigeria through the recent opening of three branches by Jaiz Bank Plc, according to Bintunde cited in Amurie&Uko (2012) Jaiz Bank Plc plans to increase its number of branches to ten within the year; this holds serious implications for human capital in Nigeria. Lotus Capital Investment which was recently mentioned on the Nigeria Stock Market through the Central Bank of Nigeria (CBN) which was to hire experts who specialize in Islamic banking industry in Nigeria has added more need to human capital development and staff training. Some Nigeria universities such as Bayero University, Kano (BUK) and Usman Dan Fodio University, Sokoto (UDUS) have included the study of Islamic Banking in their curriculum. Recently Ahmadu Bello University (ABU) collaborated with the Islamic Banking and Financial Institute Nigeria (IBFIN) in providing the public with short courses in Islamic finance. Islamic banking industry stakeholders also contribute to Human Capital Development through organizing seminars, conferences, symposiums and so on.

Islamic banking industry provides funding for scholarships from Zakah (alms giving) account. The Islamic Development Bank (IDB) and Bilingual Education Programme intend to support the Nigeria government with $98 million to integrate and modernize Almajiri and Tsangaya schools in bridging the gap between the two educational systems: the Madrassa (Islamic Schools) and formal schools (Chiejina and Ochigbo, 2012).

Economic Potentials of Islamic Banking in Nigeria Islamic banking has become an integral part of the global financial service industry,

growing rapidly in both size and nature. Total Islamic asset today are valued at over $1.1 trillion. The major geographic markets are Iran, the Kingdom of Saudi Arabia, the United Arab Emirates, Malaysia, Kuwait, Qatar, Turkey and Pakistan (Garbois, 2012). The field of Islamic finance is evolving and Islamic financial instruments have been developed to cover nearly all kinds of businesses including Consumer Financing, Import and Export


Financing, Venture Capital and so on (Memon, 2007). Hence the venture into Islamic financing in Nigeria has some major economic implications. According to Dogarawa (2011) the introduction of Islamic banking in Nigeria is timely and very important. This is because the system has been proven to be a viable financial intermediation channel in supporting economic growth: it has many significant untapped business potential in the country.

The Islamic Financial system according to Dogarawa (2011)is expected to, among other things, act as a vehicle for mobilizing funds that have been outside the interest-based banking system for productive purposes, in particular for Muslim communities; generate additional employment; serve as means of achieving financial inclusion; promote quality service and healthy competition; attract investment especially from the Middle East; provide opportunity for man-power development; capacity building and expertise exchange; generate additional employment; promote quality service and healthy competition and fulfill the demand of not only the teeming Muslims but also the non-Muslim population.

Islamic banking as a vehicle for fund mobilization Nigeria is the most populous black nation in the world with a population of over

150 million. A sizeable proportion of the population (Muslims and Non-Muslim) yearn for Islamic Financial Service. Research has shown that many people in Nigeria, particularly Muslims do not care for banking with conventional Banks because of the interest attached. Surely, the establishment of Islamic Banks in Nigeria will help mobilize these unbanked funds and provide more investible funds.

Islamic banking as a means for achieving financial inclusion Researches have shown that commercial banks are reluctant about giving out loan

facilities to Small and Medium Scale Enterprises (SMEs). The essence of inclusive financial is to ensure that variety of suitable financial service is available to every individual at an affordable price and to enable them know how to access these services. With the establishment of Islamic banks in Nigeria it is expected that all members of the society can have equal access to banking facilities.

Impact on the rate and pattern of growth The likely impact of the adoption of Islamic banking practices in the Nigeria

economy will impact a pronounced growth orientation. The increased availability of capital as a result of adopting the Profit and Loss Sharing (PLS) mode is expected to increase investment, technological innovation and experimentation which would be another favourable factor as growth is spread based on optimal use of bank resources for achieving socio-economic objectives. The Central Bank of Nigeria (CBN) will have to play a major role in guiding this context.

Exchange of expertise The Islamic finance industry is a multi-billion dollar industry developing a global

reach and momentum. The establishment of Islamic Banking in Nigeria and Nigeria’s membership of the Islamic Development Bank (IDB) brings with its prospects for strategic partnership and linkages with other global financial institutions offering Islamic financial service. Establishing Islamic Banks in Nigeria will give her opportunity to benefit from Islamic Development Bank (IDB) programme in at least three ways.



a. Support Islamic financial institutions with expertise through the technical assistance and training programmes of Islamic Research and Training Institute (IRTI), a specialized unit of the disciplines of Islamic Banking and Finance and Islamic Economics.

b. Extension of scholarships in the discipline of Islamic Banking and Finance and Islamic Economics

These benefits will have a positive multiplier effect on the economy by strengthening the world’s effort to incorporate faith-based institutions in the fight against poverty and provide a platform for manpower development and capacity enhancement.

Employment generation and Promotion of quality service and health competition

With unemployment being a serious problem in Nigeria as tens of thousands of university graduates are currently unemployed. Islamic Banks are expected to create job opportunities both directly and indirectly. Directly through employment of staff members to help run Islamic Banks and indirectly through jobs created by giving business ventures funding facilities. Shittu (2013: 28) has reported some unhealthy situations with conventional Banks, thus: poor service delivery to customers, staff abuse and unhealthy competition among Banks. Islamic Banks however expected to break the ring of monopoly that conventional Banks are enjoying in Nigeria, which in turn will prevent Banks from charging excessive rates as well as hidden charges.

Argument for and Against Islamic Banking in Nigeria Following the release by the Central Bank of Nigeria (CBN) of its draft framework

for the regulation and supervision of non-interest Banks in Nigeria, a lot of arguments for and against establishing Islamic Banks in Nigeria have been raised by stakeholders and the public at large, these arguments vary in nature, some arguments are based on economic grounds while some are purely religious in nature and other political, legal, social and security issues.

Proponents of Islamic Banks argue that in today’s world, the economic system that is based on interest has resulted in concentrating wealth in the hands of a selected few. They argue that the banking system tends to reinforce unequal distribution of income, even Morgan Guaranteed Trust Company which is the sixth largest Bank in America has admitted that the banking system has failed to finance either maturing small companies or venture capitalists and though they are a wash with funds, they are not encouraged to deliver competitively priced funding to any but the largest companies, hence while deposits come from a broader cross section of the population, their benefit goes mainly to the rich.

Opponents of Islamic banking in Nigeria have raised questions on the legality of establishing Islamic banking in Nigeria, the motive behind such an establishment in Nigeria and its social implication on non-Muslim Nigerians. Five major arguments against Islamic Banks in general are raised:

First, is Islamic Bank really interest-free? Some have argued that the money considered as interest in a typical Bank transaction is instead designed into the contract


agreement in another way. This is considered as hidden interest; some Muslims consider Islamic Banks to be engaging in legal trickery to hide the fact that they charge and pay interest. Ogundairo as cited in Economy Watch (2012) in accordance opines that rather than charging interest, Islamic Banks charge a fee, the service of lending and such a fee can be shown to be mathematically identical to or in some cases, even more than the interest charged by Commercial Banks. Hence, to him the distinction between ‘Interest-Free’ and ‘For-Interest’ banking is merely a matter of semantics.

Second, Islamic Banks have acted for decades as avenues for funding terrorist activities. According to Herard (n.d.), there have been claims that certain Banks funded terrorist networks indirectly and ought to be stopped. He mentions Al-Rajhi Bank as being focus on such criticism. He explains that since Zakah (alms giving) can be given to anyone and need not to be accounted for in the books because it is meant to be community charity-giving, it has been a great tool for terrorist network to receive funds and to prevent anyone from finding out where the funds came from. This is gross abuse of the aim of Shari’ah (Islamic Law) to help the needy.

Third, argument by some opponents of Islamic banking is the Islamic worldwide view which supports a mentality and value system which attributes little importance to individual performance and responsibility, effectiveness and efficiency or material well-being. They argue that Muslims are only concerned with the hereafter, their belief in predetermination (destiny) and all these components lead in total to a fatalistic attitude which seriously obstructs economic development, hence Islamic economic is seen as a threat to development (Saleem, 2008).

Some opponents of Islamic banking also see Islamic banking as a threat to peace and stability of the nation owing to the fact that the nation has been experiencing security challenges from self-proclaimed Islamist group. On this issue, Ayilara (2011) notes that for a nation passing through the Boko Haram crisis, with the group’s insistence on the Shari’ah (Islamic Law) as the legal code and Islam as the official religion, the timing for introduction of Islamic banking is obviously wrong and destabilizing. He explains that religious partition of a nation already fragmented into several discordant units based on tribe, tongue and tradition seems assured. Bearing in mind the history of religious crises in the nation; the Shari’ah Court of Appeal crisis of 1979 and 1999; the Maitsaine riot of early 1980s and ongoing Boko Haram crisis, the disunity within the country on the basis of ethnicity and religion and the political aggregation of a disparate North, West and East which from the onset and till today has not been properly harmonized and is still simmering in the National Assembly, Islamic banking would destroy the only area where Nigerian have since inception been one and indivisible, the area of commerce.

Another argument against Islamic Banks is the issue of its legality, opponents of Islamic Banks have argued that establishing an Islamic Bank in Nigeria is unconstitutional owing to the fact that the Nigeria 1999 constitution and 2001, prohibits the adoption of any of form of State Religion. They argue that establishing an Islamic banking in Nigeria goes against the constitution and that is establishment will create a platform for Islamic propaganda to the detriment of non-Muslims in Nigeria (Akinterinwa, 2011).

Challenges facing Islamic Banking in Nigeria Organizing and embarking on the development of an Islamic Commercial Bank in

any economy’s financial system is a difficult and complex task. By embarking on a



financial system, which is new to the Nigerian economy, it is expected that this effort will be confronted by challenges both to the policy maker and Bank operators. According to Mohammed (2011) on the part of the policy makers, the challenges are in the form of Regulatory and Supervisory aspects. Bank operators on their part face largely operational challenges. Dogarawa (2011); Karimi (2004); Mohammed (2011); Sanusi (2011) explain challenges faced by Islamic banking in Nigeria as follows:

Liquidity: One of the challenges faced by Islamic Banks is acquiring liquidity. Islamic financial institutions depends largely on the short-term and liquid funds. An Islamic financial system requires short-term instrument for mobilization as well as disbursement are to be found in inter-bank operator, treasury bills, government bonds and various money market operators such as Bankers’ Acceptance and Discounting Bills but all these are interest based and therefore not available to an Islamic financial institutions. Hence Islamic financial institutions are reluctant to go into long term transactions.

Quality of Management: If Islamic Banks are to operate within the country’s Tijari (commercial sector and laws) and mobilize its funds from the public, partly in the principles of Al-Wadiah(safe custody) by largely on al-Murabaha (Profit and Loss Sharing) principle, then it is inevitable that the Banks continued existinance will depend solely on its viability; this makes the task of attracting customers more difficult for Islamic financial institutions than it is for conventional banks.

Absence of Islamic Insurance (Takaful): Conventional Banks have at their disposal insurance to protect their investment against unforeseen hazards and also a Deposit Insurance Scheme which is used to protect depositors. The absence of Islamic Insurance (Takaful) scheme makes Islamic Banks vulnerable to loss of investment hence jeopardizing the success of Islamic Banks. Since deposit in Islamic banking are usually based on the principle of Profit and Loss Sharing (PLS), if something happens and the Bank suffers loss it has to be transferred to the depositor directly. The fear of loss is the biggest barrier to deposit mobilization in Islamic Banks. In some cases, it leads to withdrawal of funds. The depositors should be provided with some kinds of protection.

Lender of last resort: When Banks are faced with liquidity crunch, the Central Bank of Nigeria (CBN) provides loans to Banks. Islamic Banks cannot benefit from these funds as they are usually provided on the basis of interest, hence the need is to devise and implement an interest-free framework for such assistance.

Misconception and Dearth of Knowledge of Islamic Banks: There is a lot of misperception about Islamic banking in Nigeria, and with the ethno-religious diversity of Nigeria, it makes it imperative to create mass awareness and acceptance. This is in view of the fact that religion has become a volatile issue over the years. Misinterpretation of the concept might jeopardize its success. Insufficient knowledge, skills and technical capacity to regulate and supervise Islamic Banks on the part of policy makers and dearth of Shari’ah (Islamic Law) scholars knowledgeable in conventional economics.

Requirement imposed on Banks by relevant regulatory and supervisory Institutions: The requirement of Banks desiring to provide Islamic financial service to comply with relevant standards issued by Accounting and Auditing


Organisation for Islamic Financial Institution (AAOIFI), Islamic Financial Services Board (IFSB), Central Bank of Nigeria (CBN) and other relevant bodies no doubt pose a great challenge of resources such as manpower and financial resources to the industry. There is a dearth of knowledge about the reporting procedure of interest-free banking and very little is known about them in Nigeria. Also the Central Bank of Nigeria (CBN) has some basic requirement for the operation of non-interest banking in Nigeria such as capital base of N10 Billion for a starting Islamic Bank, raising this amount may prove to be a challenge.

Nature of existing banking and company Laws: Another problem facing Islamic Banks is the nature of banking and company laws already existing in Nigeria. Existing banking and company laws contain provisions that narrowly define and prohibit the scope of Islamic banking activities within conventional limits. This means that issues regarding Islamic banking activities are subject to the same legal system as conventional banks even though the nature and practices of an Islamic legal system is totally different. In order to suit the needs of Islamic Banks, Nigeria policy makers will have to amend existing laws to be Shari’ah (Islamic Law) compliant, create special courts through which disputes regarding Islamic banking and finance can be settled and the modification of existing company and banking laws in order to create a level playing field for Islamic banks. Furthermore international acceptance of Islamic financial contracts requires them to be Shari’ah compliant as well as acceptance under the major legal regimes.

Double taxation levied on Islamic Banks as a result of stamp duties and capital gain upon asset transfer: This is another challenge which Islamic Banks face because their financial intermediation is mostly assets based. In home financing for example, the Islamic Banks take possession of the asset either through Sale or Construction Contract, and they pay Stamp Duty for that. When they re-sell the asset to a customer through Mark-up Sale or a Lease lending with Ownership Contract, another Stamp Duty is charged for the asset transfer. Other jurisdictions, including the United Kingdom and Luxembourg have modified their Tax laws to exempt Islamic Banks from double taxation on Assets they acquire for financing purposes.

Another challenge related is the taxation of profits generated by Islamic Banks with regards to financial instruments they offer. Islamic Banks are not given tax relief which conventional Banks enjoy on debt instruments. Debt instruments issued in Nigeria are currently exempted from taxes including income tax and Value Added Tax (VAT). Similarly interest payments on loans advanced are given the same relief. The same status should be granted to a Murabaha (cost-plus) or Ijarah based (leasing) financing.

Conclusion The development of Islamic banking in Nigeria has potential high spill-over effect,

both on the financial sector and other sectors of the economy through financial inclusion, mobilizing unbanked finances, exchanges of expertise, encouraging healthy competition within the banking industry, employment generation and so on. However, a multiplicity of problems, such as, dearth of knowledge, quality of management, misconception, to mention a few, are seen as major hindrances to the development of Islamic banking in Nigeria.Human capital development by the industry, academia and stakeholder in general will be the differentiating factors that will contribute to the success of the Islamic banking industry as a financial institution and as a means of achieving macro-economic policies such as a locative efficiency and social justice.



Recommendations Undoubtedly, Islamic banking portends a number of economic benefits to Nigeria.

However, to promote the development of Islamic banking in Nigeria and to actualizing its economic benefits, it is suggested that the Central Bank of Nigeria (CBN) and Islamic Bank operators need to address these issues.

Effective regulation of Islamic Banks by relevant authority like Central Bank cannot be down played. A framework should be put in place to monitor the capital adequacy, risk management controls, Islamic law compliance and adequate customer disclosure to prevent money laundering. Massive Sensitization Campaign is required intermittently. The Central Bank of Nigeria, bank operators and all stakeholders should embark on sensitization through public lectures, seminars, workshops, conferences and adverts using the media to create awareness on the principle of Islamic banking, and services provided. This will help clear misconceptions about Islamic banking and create awareness among the general public (both Muslims and Non-Muslims) on the principles of availability of this banking service.

A comprehensive review of existing banking and company laws should be carried out by the Central Bank frequently. This is needed to accommodate the unique features of Islamic banking and ensure a level playing field with conventional banks. Human capital development needs to be comprehensive and holistic in meeting the requirement for all levels. Human capital development should encompass attracting and developing talents with required skills and expertise for the industry. Human capital development practices should go far beyond the circle of the financial services community, to include other business communities such as legal, government officials and information technology (IT) providers.

Raising standard of training and education programmes is paramount. The education and training programme in the Islamic banking sector needs to achieve the highest quality, be credible and globally recognized. The qualifications developed should fulfill the expectations of the industry. A body dedicated to raising the quality standards and professionalism of Islamic banking practitioners should be put in place. This will centralize the setting of standards and ensure they are being met. As a result, the Islamic banking industry in Nigeria, its human capital for Islamic banking and its education practices for the industry will be able to compete with its counterparts anywhere in the world.

Partnership and collaboration within the industry and academia will enhance consolidation and effectiveness of policies. There needs to be greater partnership and collaboration between the industry and academia to align training and development with the requirements of the industry. Financial institutions should be involved in the process of designing the academic and training curriculum and providing real business exposure and training through internship and sharing of experiences. Focus on Research and Development (R&D) is required greatly. Research is also a valuable investment for sustainable development and competitiveness of Islamic banking industry in Nigeria and a driver for innovation. Research institutions together with the industry must continuously strive towards introducing innovative solutions which will add to the diversity of products available in order to cater for the equally diverse needs of their customers.


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The Practical & Behavioral Issues of Islamic Economic System

By Muhammad Zeeshan Farrukh∗

Abstract Due to the consistent failure of conventional economics and finance in achieving economic goals, the need for an alternate system is being felt at every level in the world.

Being Muslims, we believe that Islam is a complete code of life and presents the complete and ideal lifestyle and socio-economic system for humanity that could lead to the real welfare of society. Therefore, there is a need to make analysis for developing proper strategy to present and implement the Islamic economic principles at the local and global level.

Now we are living in a global village where we are dealing with different nations, regions, communities, religions and thoughts. So it is mandatory to think, study and implement the golden principles and practices of Islamic Economic System in a global scenario rather than keeping them confined to only Muslim countries as the Muslim world cannot live in isolation in this time of globalization.

Keeping in view the above-mentioned scenario, this article discusses and analyzes the maximum possible hindrances, issues and challenges, while striving towards practicing Islamic Economic System, with respect to different possible behaviors expected from different schools of thought and beliefs of society and then presents the possible recommendations in this respect. The points discussed in this article may pave the way of serious thinking in this direction and requires concrete steps at authoritative and concerned levels.

Key Words: Islamic Economic System, Capitalist, Just Economic System

∗ Author: Muhammad Zeeshan Farrukh, Team Leader-Training & Development Unit, Islamic

Banking Group of National Bank of Pakistan, E-mail: [email protected],


A. Behavioral Differences of Society While we will go to local and global level, we may face behavioral differences

including, but not limited to, the following:

1. The people who are the followers of Islam and accept Islamic injunctions with blind faith and heart and soul. This category will not resist the Islamic economic principles as being a Muslim, it is the responsibility and duty of every Muslim to obey the commandments of Almighty Allah without rasing any question and going into real logic behind the commandment. These people may be taught and convinced with references from the injunctions of Islam.

2. The people who are the followers of Islam but want their religion separate from the socio-economic scenario. These are the people who declare themselves Muslims but take inspiration from the Western or conventional thoughts and practices. We call these people as Secular. This category does not like religious interference in worldly life and they have a materialistic nature. These people may be convinced by references to Islamic injunctions with proper comparison to conventional practices along with proper logic of Islam behind the rule.

3. The people who are the followers of Islam and practicing Islamic economic and banking principles as well but with conventional mindset. These people are convinced of the Islamic economic principles but want results the same as conventional systems through shariah compliant economics, banking and finance practices. In this respect, the transactions are even camouflaged to get the same results as conventional one. Since Islamic economics is different from the conventional one, anything cannot be transformed or executed to obtain the same results. There is a need to understand the boundaries of Islam and Islamic economics. This factor is present in the prevailing banking and finance practices and it may be discouraged by proper shariah compliance and audit instructions and guidelines. Although these people practice Islamic banking and finance etc. but have a materialistic approach. This segment may be tackled with research and development of real Islamic modes of finance. This segment will not help in the real implementation of Islamic economic system.

4. The people who are the followers of Islam but support capitalism and do wrong interpretation of Islamic injunctions etc. These people are also materialistic in nature and habitual to make interpretations of Islamic injunctions in a way that suits and favors prevalent capitalist economic system. This is a very tragic self-centric approach that leads to even wrong interpretation of Islamic injunctions. This segment may be tackled seriously by strong Shariah scholars by making proper and logical references from the history and philosophical basis of the guidelines and instructions of Islam.

5. The people who are not the followers of Islam but biased towards Islamic injunctions. In this case, the reference of Islam would not be used that anyone may reject on mere basis of his biased behavior but should propagate Islamic Economic System by labeling it as a Just Economic System (JES) and the principles, commandments and guidelines of Islamic Economic System must be presented as economic theories that may lead the world towards an ideal welfare place. In this


respect, the evils of conventional system and their consequences must be propagated with proper details, reasoning and analysis that no one can refute or defend in any way.

6. The people who are not the followers of Islam but religious scholars of different religions who want to implement the economic and business practices of their beliefs. It is a fact that no religion can favor Interest based transactions and other unethical transactions and activities of prevalent economic structure. Through the proper harmonization upon similar issues, the scholars from different religious thoughts may formulate a proper plan to abolish this system and propagate an ethical economic system which will indirectly bolster the implementation and practices of Islamic economic system. If a world movement of religious scholars against the prevailing economic structure gets started, it would definitely have an effect upon the behavior of the society. Therefore, there is a need to unite religious scholars upon common issues like interest-based transactions etc. that are the key evils of the prevalent system.

7. The people who are economic scholars and intellectuals who are not convinced with the prevalent interest-based or unethical practices. It is a fact that no sensible person will favor the prevalent exploitative and counterfeit system. As far as this segment is concerned, they may be convinced very easily by being providing viable alternatives as compared to conventional counterpart.

8. The people who do not follow any religion i.e. Atheist.

The strategy of Point No. 5 may also be followed in this case. This segment will not be considered as included in any religion or revealed order in any sense so the concept of life of the hereafter has not value for these people. This sector may be tackled on pure logical, scientific and humanitarian grounds with the explanation of the ethical issues of prohibition of interest, excessive speculations and other evils of conventional economy.

9. The people who are capitalists and favor prevalent bogus economic structure. These people will not be convinced in any way because they have vested interests in this system. These people will defend this system at any cost. This category will only be defeated if the other segments of the society will agree to change the prevalent structure.

B. Considerations & Actions For Effective Penetration Keeping in view the above-mentioned expected behaviors of the society, the

considerations and actions for effective penetration including, but not limited to, the following:

Targeting Influential Personalities People generally follow or obtain inspirations from certain people in a society.

These people have significant influence upon society. There is a need to target those people because when these sources of inspiration will be convinced, the general public will also be convinced and follow them. Different influential personalities may belong from different behaviors and thoughts and they must be tackled and convinced keeping in view their specific thinking.



Quality of Scholars The quality, ability and mindset of people to tackle or convince behavior and

situation should not be compromised. For example, in case of Islamic bank, if any person comes to relationship officer for understanding or clarification of certain issue or Islamic Banking, the concerned officer must be equipped with suitable knowledge that can provide suitable answer to the query. In case the officer considers that he is not capable to make suitable answer, he must refer to anybody else but should not make inadequate response or wrong delivery that can cause a bad impression or dissatisfaction the of person. In the same way and in a broader scenario, the issues of Islamic economics must be conducted judiciously.

Joint Forum of World Religions As already mentioned in this article, there is a need to make active forum of learned

scholars from different religions that are able to make effective positive propaganda regarding prohibition of prevalent economic practices in different religions and their consequences in the worldly life as well as the life hereafter. The separate and joint propaganda must be performed through different forums, conferences, seminars and general awareness programs with the intention to convert the mindset of people. These activities will definitely pave the way for achieving the economic objective of Islam.

Continuous Research & Development & Coordination The factor of research and development is crucial at local and international level

and this process must not be stopped. While facing various socio-economic issues, scenarios, practices, laws etc and while interaction with different socio-economic behaviors of the society at local or global level, the best suitable and viable effective shariah compliant solutions are required.

The formulation of proper forums and institutions at regional and international level with the appointment of adequate scholars with required expertise and their effective coordination are mandatory in this respect.

It is essential to prevent major clashes in Muslim Ummah upon certain issues as it would impact negatively on practice and implementation of Islamic economic system. Likewise, the international bodies having representation of Muslim scholars from all over the world that can issue uniform standards and regulations that can be practiced and implemented by different regions according to their certain circumstances and socio-economic environment should be enhanced.

In these forums, the representation of recognized western and non-Muslim scholars must also be considered for advisory and understanding of the current scenario and this representation will show positive effect at the global scenario while striving for implementation of Islamic Economic System.

Arrangement of Information Conferences & Seminars It should be mandatory to arrange conferences and seminars all over the world

having representation from Muslim and Non-Muslim communities to build confidence at the global level and in this way, the better understanding of Islamic Economic principles and comparison of Islamic Economic System with conventional economics will be achieved.


Flexibility & Patience

There is a need for flexibility, patience and proper psychological analyses. The aggressive and impatient attitude without any proper planning and mere emotional steps would not give required results. A strategy is required in a way that the other party to whom we are delivering must accept the principles by heart and soul and with proper understanding.

Gradual & Planned Implementation We cannot change the mindset of the whole world or change the world’s socio-

economic scenario overnight. It is a continuous process and needs gradual and planned penetration and implementation from time to time at different socio-economic levels.

The strategy must be made in a way that people can understand, compare, assess, adopt and practice the best alternative. As any new thing cannot be adopted at once; the same is the case of Islamic economics and finance that we cannot expect that the society will be convinced and change their preferences immediately. The aggressive, fast and ill-planned process will not be possible at all in this respect.

Example of Islamic Banking & Finance The recent development and success of Islamic Banking & Finance may further

pave the way for implementation of Islamic Economic system. Islamic Banking & Finance has proved itself as a viable option of Banking & Finance and it has been recognized around the world even better than its conventional counterpart. While stepping towards implementation of Islamic Economic System, this factor of success must be highlighted before different segments of the society.

Commitment of Muslim Ummah To succeed towards the implementation of Islamic Economic System at the global

level, the Muslim Ummah must show commitment and undertake concrete and effective actions in this respect. We cannot inspire the world without having an effective practical approach in this direction. The non-shariah compliant socio-economic activities that can be banned or stopped immediately must be ceased at the government level.

In this regard, it is the responsibility of every Muslim to obtain knowledge and understand the Islamic economic principles and do work to the maximum possible extent according to their capability and capacity in this important task.

Disclaimer: The views expressed in this article are those of the author only and do not necessarily represent the views of National Bank of Pakistan.



Islamic Financial Services Patronizing Behavior in Tatarstan: An Exploratory Study

By Ruslan Sabirzyanov* Muhamad Abduh**

Abstract: Despite the tremendous growth shown by global Islamic financial services industry, there are Muslim minority countries that have not embraced Islamic finance yet and Russian Federation is one of them. This research is aimed at investigating the people patronizing behavior towards Islamic financial services in the Republic of Tatarstan, the Russian Federation. The theory of reasoned action is adopted to examine the factors affecting Tatarstan citizens’ behavioural intention to patronize Islamic financial products and services. Sample size of 517 is available for analysis. Confirmatory factor analysis and structural equation model were used as the method of analyses. The finding shows that awareness had positively influenced people’s attitude towards Islamic financial services and subjective norms had positively influenced the intention to patronize Islamic financial institutions. This study evidences that in order to attract more people to patronize Islamic financial institutions, Islamic bankers in Tatarstan can approach people perceived important by the people of Tatarstan such as scholars and teachers.

Keywords: Islamic finance, patronizing behavior, TRA, Russia, Tatarstan

1. Introduction The Republic of Tatarstan is not an independent state but a constituent republic of

the Russian Federation, one of the country’s 85 federal subjects. The population of the Republic of Tatarstan numbers around 3.838 million and comprises representatives of

* Authors: Ruslan Sabirzyanov is affiliated with IIUM Institute of Islamic Banking and

Finance, International Islamic Universiti Malaysia. ** Muhamad Abduh: Department Accounting and Finance. School of Business and Economics,

Universiti Brunei Darussalam.


115 ethnic groups; these include Tatars (53.2%), Russians (39.7%), Chuvashes, Udmurts, Mordva, Mari, Ukrainians, Bashkirs and others. 76.1% of Tatarstan residents live in urban areas. Over thousand religious societies have been registered in the territory of the Republic of Tatarstan. The most widely spread religions are Islam and Orthodox Christianity. The Sunni Islam was adopted as official religion in the Volga Bulgaria as early as in 922. At present, it is professed by a majority of Tatars and Bashkirs. The supreme body of Muslims is the Religious Muslim Board of the Republic of Tatarstan.

Tatarstan is among the group of Russian regions with high level of social and economic development. In 2011, Forbes and Ernst and Young ranked Tatarstan as the best region for doing business in Russia. The Republic of Tatarstan is ranked in Russia’s top ten regions in terms of the gross regional product with 1,436 billion roubles in 2012. Economic growth has been stable for the past 5 years with the exception of a recession in 2009 due to global financial crisis.

There are several institutions involved in Islamic financial services, namely the Islamic business and finance development fund (IBFD Fund), the Tatarstan International Investment Company (TIIC), Financial House “Amal” (FH-Amal), TatAgroPromBank, the Russian Centre of Islamic Economics and Finance (RCIEF) and Centre for Islamic Economics and Finance Development (CIEFD). TIIC and FH-Amal are merely Shari’ah compliant financial institutions doing financing and investment on the basis of ijarah, murabahah, musharakah and mudarabah. On top of that, FH-Amal accepts deposits on the basis of qard and mudarabah. TatAgroPromBank, in its turn, has not started its Islamic banking operations. However, it is currently developing Islamic banking products and services suitable for Tatarstan and Russian markets. IBFD Fund, RCIEF and CIEFD are key players in Islamic economics and finance education and training in Tatarstan particularly and in Russian Federation in general. These institutions are spreading the knowledge, removing public ignorance and increasing the level of awareness pertaining Islamic economics and finance.

Despite the aforementioned activities, all of the aforesaid organisations reported the low level of recognition and familiarity of Islamic financial products and services by the Tatarstan people. Moreover, the level of awareness among potential consumers of Islamic financial products and services is very crucial in order to develop this sector of finance.

Having this in background, this empirical research aims to explore the role of perceived values and awareness in Islamic financial products and services towards patronizing behaviour of the people in Tatarstan. This study can help to determine the level of awareness of Tatarstan people toward the Islamic financial products and services, which facilitates further researches in this field in order to develop this promising industry. This research will also help existing Islamic financial institutions in Tatarstan to better understand the market, which, eventually, could be a reason for further expansion of their businesses.

2. Literature Review 2.1 Review on Previous Studies

To date Islamic banking and finance attracts more and more researchers in different countries. One of the aspects that are studied is consumer behaviour. Level of awareness and perception of customers are viewed as one of the main concerns for providers of

Islamic Financial Services Patronizing Behavior in Tatarstan


services and products in any sector of the economy of any country. Islamic financial products and services industry, in its turn, does not remain aside, but also acknowledges the importance of consumer behaviour understanding. Furthermore, understanding the changes in consumer behaviour and proper adjustment of business in line with these changes are necessary for any financial institution to remain competitive in the market.

Considering the structure and composition of Tatarstan population, the most interesting and relevant researches seem to be Turkey, Kazakhstan, Uzbekistan and Dagestan. Turkey, despite the fact of vast majority of its population being Muslims, is a secular country, where, until now, there is no special legislation for Islamic financial institutions, specifically for Islamic banks. Islamic banks in Turkey are called as participatory banks. Kazakhstan, in its turn, is also a Muslim majority country with civil law system similar to Russian. Moreover, Kazakhstan is the first Commonwealth of Independent States (CIS) country, which amended its law to accommodate Islamic finance. Uzbekistan is another CIS country with vast majority of population ngbei Muslims. Still, the legislation for accommodation of Islamic finance is yet to be introduced. However, the Republic of Dagestan is one of the states of Russian Federation like the Republic of Tatarstan, which in turn, both Tatarstan and Dagestan states are of one legal framework set by the Federation.

Okumus and Genc (2013) conducted a study on customer satisfaction and interest-free bank selection in Turkey using 281 responses on given questionnaires. As in previous study majority of respondents chose interest-free banks on religious grounds. However, only about 45% used only participation banks, whereas, remaining 55% used both participation and conventional banks. Among the most important reasons of utilising conventional banking, with 50-60% of response rate, are ‘some products not available at participation banks’, ‘insufficient branch network of participation banks’, ‘lack of available credits with favourable terms in participation banks’’ and lack of credit cards with favourable terms participation banks’. All in all, Islamic banks in Turkey should come up with more products and services to satisfy the needs and demands of the current and potential customers. Furthermore, expansion of branches throughout the country is a vital step for the growth and development of the whole Islamic banking industry in Turkey.

With a Muslim population of 281,000, which is a mere 1.5% of the total population of Australia, Islamic finance in Australia cannot obtain government support like in other Muslim minority countries where the proportion of Muslim population is more than 20% of the total country’s population. Despite that, Islamic finance is growing in this country and has a bright future. As awareness is one of the most important factors for any product, Rammal and Zurbruegg (2007) conducted research on the awareness of Islamic banking products among Muslims in Australia. The selection criteria for the survey ensured that respondents were potential customers of Islamic banks. With 300 questionnaires being distributed, 89% of respondents were male. Major findings of the study indicate a willingness of the Australian Muslim community to move to Islamic banks as long as Islamic banking services are competitive with their conventional counterparts. Yet, certain products play crucial role for the potential Islamic banking customers, such as credit facility, brand of the bank et cetera. Moreover, lack of knowledge of basic rulings and principles of Islamic finance is one of the obstacles for Islamic financial institutions to gain momentum in Australia. As a result, educating


Muslims about principles of Islamic finance and increasing Muslims’ awareness about Islamic financial services are two things that must be done in order to increase market share of Islamic financial institutions. Not only that, Islamic banking services should be competitive with their conventional counterparts to meet the needs and expectations of the customers.

Kazakhstan is very close to Russia in many aspects and the legal aspect is one of them. Civil law governs both Russia and Kazakhstan. Being parts of the Union of Soviet Socialist Republics (USSR) leaves its mark on the current legislation of both countries. Nonetheless, Kazakhstan is one step further in terms of development of Islamic finance in the country because it has special legislation in order to accommodate Islamic banking and financial practice. Nevertheless, Islamic finance is still at its infancy level, thus competition with conventional finance, which has much longer history than Islamic finance, urges to know the awareness of Muslim population regarding Islamic finance.

Abduh and Omarov (2013) conducted research on Muslim’s awareness and willingness to patronize Islamic banking in Kazakhstan. The research targeted only Muslim population of Kazakhstan, which constitutes 65% of total population. This number is similar to that in Republic of Tatarstan. The research used self-administered questionnaires to collect the data. From 400 questionnaires distributed in 5 major cities of Kazakhstan only 300 were available for analysis. The study employed descriptive analysis to obtain the information gathered from the respondents. Vast majority of respondents were from 20 to 49 year old, i.e. economically productive age; and most of them (83%) know about existence of Islamic banking in Kazakhstan. Those who are aware of prohibition of interest in Islam are of the same percentage. Yet, when it comes to principles of Islamic banking, Islamic banking products and differences between Islamic and conventional banking, only 14-16% of respondents know about them. Nonetheless, more than 70% of respondents believe in a high potential of Islamic banking in Kazakhstan and that Islamic banks are able to compete with conventional counterparts and, what is probably most important, they are ready and willing to become clients of Islamic banks in Kazakhstan. They also stated that there is a lack of marketing for Islamic banks. Therefore, it is very important to provide more information pertaining to Islamic banking products and services to the public in order to promote this sector.

Uzbekistan is another country with a law structure similar to Russia. Shaamirova (2014) conducted a research on public perception on the feasibility of introducing Islamic banking in Uzbekistan looking at consumer perspective. As many as 240 responded questionnaires were available for the study. The data was analysed in two stages. First, descriptive statistics method was used. As for second stage, Confirmatory Factor Analysis (CFA), Measurement Model, and Structural Equation Modelling (SEM) were employed. Results of the research show that religious factor plays crucial role in patronizing behaviour of Islamic banking customers. However, attitude and knowledge do not have positive effect on behavioural intention to patronize Islamic banking, as only almost one third of respondents know the difference between Islamic and conventional banking. Furthermore, profitability, quality of services, location, et cetera has an influence on customers’ decision-making criteria regarding Islamic banking.

Abduh and Idrisov (2014) conducted study on the role of perceived values and awareness upon the acceptance of Islamic financial products and services in Dagestan.



Dagestan is a state of Russian Federation like Tatarstan. With vast majority of Muslim population, it is a second state of Russia where Islamic financial institutions started their operation. The study employed a survey with 400 responses. This research used similar techniques for data analysis as the one conducted in Uzbekistan (Shaamirova, 2014). Results have shown, that 98% of those who were surveyed are Muslims, and just more than half of them have heard about Islamic finance. Moreover, only mere 6% are familiar with Islamic financial contracts. Nevertheless, around 70% are willing to become customers of Islamic bank. One of the issues that emerge from these findings is public ignorance pertaining to basics of Islamic finance. Therefore, the study suggests that education of public should take place to promote Islamic finance industry.

2.2 Theory of Reasoned Action This study attempts to determine the factors influencing Islamic financial products

and services patronizing behaviour of Tatarstan people. In order to achieve this objective, Theory of Reasoned Action (TRA) of Ajzen and Fishbein (1980) is employed. The strength of this theory lies on its ability to predict the behaviour using several external and internal factors. Razak and Abduh (2012) is among previous studies using TRA in Islamic finance cases, particularly the intentional behavior of Islamic bank customers to subscribe to musharakah mutanaqisah home financing.

Behavioural intention of people of Tatarstan toward Islamic financial products and services can be predicted by several factors among which attitude, subjective norms and perceived values which can be done using TRA model. Based on Abduh and Idrisov (2014), awareness is regarded as external variable and has positively influenced attitude. This research, however, adopts and adapts the aforementioned model and thus awareness of people in Tatarstan toward Islamic financial products and services is considered as an external factor. The modified and proposed theoretical framework is illustrated in Figure 1.

Figure 1. Modified and Proposed Theoretical Framework

Based on the aforesaid studies, the following four hypotheses were developed: H1: Perceived values have a positive effect upon the intention of the people to patronize

Islamic financial products and services in Tatarstan. H2: Subjective norms have a positive effect upon the intention of the people to

patronize Islamic financial products and services in Tatarstan. H3: Attitude has a positive effect upon the intention of the people to patronize Islamic

financial products and services in Tatarstan. H4: Awareness has a positive effect upon the attitude of the people towards patronizing

Islamic financial products and services in Tatarstan.

Perceived values

Awareness Attitude

Subjective norm

Intention to perform

Behaviour


3. Data and Methods 3.1 Data

The data was collected from survey which was conducted using the questionnaire within six months starting from June until November of 2014. The questionnaires were distributed in all major cities of the Republic including Kazan, the capital city of Tatarstan, NaberezhnyeChelny, Almetyevsk, Nizhnekamsk, Zelenodolsk, Bolgar, Chistopol, Bugulma, Nurlat, and Zainsk. Total number of questionnaires available for the analysis after screening is 517.

3.2 Variable This study examines the relationship among five latent variables namely awareness,

perceived values, attitude towards Islamic financial products and services, subjective norms and intention to patronize Islamic financial institution. In this regard, awareness of Islamic financial products and services is described by how people acknowledge and understand contracts in Islamic finance, as well as products and services offered by Islamic financial institutions, particularly by Islamic banks. Perceived values toward Islamic financial products and services is described by how products and services offered by Islamic financial institutions can deliver additional value for them and meet the people’s extra needs or requirements. Attitude toward Islamic financial products and services is described as people’s sense of being comfortable and fulfilled in patronizing Islamic financial products and services. Subjective norm is described as the perception that significant referents think that a person should use Islamic financial products and services. In this study, the intention to patronize Islamic financial products and services in Tatarstan is used as the dependent variable.

3.3 Confirmatory Factor Analysis and Structural Equation Model Confirmatory factor analysis (CFA) is applied to inspect the number of latent

variables (constructs or factors) underlying the observed variables and to evaluate the adequacy of observed variables (indicators) for the latent variables they are supposed to measure. Basically, each construct included in the model is usually measured by a set of observed indicators. Hence, in a CFA model no specific directional relationships are assumed to be between the constructs. The assumption is only on that constructs are potentially correlated with each other. In CFA, the specified theoretical hypothesised model is statistically tested for significance, in other words, whether the sample data confirm that model. Furthermore, the number of factors is assumed to be known. The researcher specifies number factors (latent variables), which factors are correlated as well as the observed variables (indicators) that measure each factor (Schumacker & Lomax, 2010).

Structural equation model (SEM) is a statistical method that takes a confirmatory (i.e. hypothesis-testing) approach to the multivariate analysis of a structural theory bearing on some phenomenon. Typically, this theory represents ‘causal’ processes that generate observations on multiple variables (Byrne, 1998). Generally, every SEM analysis including CFA goes through the steps of model specification, model identification, model testing, and, possibly model modification (Bollen & Long, 1993). All steps will be discussed together with the output in the following section.



4. Findings and Discussion 4.1 Demography

Table 1 shows that majority of respondents of the survey are males with 62.5%. An interesting point to be put forward is that more than three quarters of respondents’ age is between 18 to 35 years, which equates to 405 respondents.

Table 1. Demography of Respondents Parameter Items Frequency Percentage

Male 323 62.5 Gender Female 194 37.5 18 – 25 years 167 32.3 26 – 35 years 238 46.0 36 – 45 years 58 11.2 46 – 55 years 22 4.3

Age

56 and above 32 6.2 Islam 411 79.5 Religion Others 106 20.5 Married 278 53.8 Marital Status Not married 239 46.2 Elementary – High school 84 16.2 Diploma 82 15.9 Undergraduate degree 294 56.9

Level of Education

Postgraduate 57 11.0 Entrepreneur 63 12.2 Government employee 48 9.3 Employee of private company

169 32.7

Student 99 19.1 Teacher 63 12.2

Occupation

Others 75 14.5 Less than 10000 rub 136 26.3 10000 – 20000 rub 145 28.0 20001 – 50000 rub 171 33.1 50001 – 100000 rub 46 8.9

Monthly Income Level

More than 100000 rub 19 3.7

Another interesting point that needs to be highlighted is that almost four fifths of respondents are confessing as a Muslim. Although, more than 40% of population of the Republic of Tatarstan are representing other religions and beliefs than Islam, only 20.5% of the respondents of the survey do not confess religion of Islam. As for marital status, the number of both married and not married groups of respondents is similar, with the number of married respondents slightly bigger than the number of not married respondents.

Furthermore, in terms of the current maximum level of education, the number of bachelor degree holders overpasses the total number of school graduates, diploma holders and postgraduate degree holders, representing 16.2%, 15.9% and 11% of the total number of the respondents respectively. As for current occupation there are two major groups


representing more than half of the respondents, namely employees of private companies (32.7%) and those involved in education sector (31.3%) comprising of students and teachers.

The last parameter is the monthly income level. Just above quarter of the total number of respondents have an income level below 10,000 Russian Roubles per month (136 out of 517). As many as 145 respondents (28%) have monthly income level between 10,000 and 20,000 Russian Roubles and about one third of the total number of the respondents state their income level between 20,001 and 50,000 Russian Roubles per month. The remaining two groups represent minority with only 12.6% of the total number of the respondents combined together.

As many as 305 respondents said that they have heard about Islamic financial institution and its products and services while 212 respondents said that they knew about Islamic banking but not clear about its products and services.

4.2 Awareness Table 2 provides the statistical results on the level of awareness of Islamic financial

products and services in Tatarstan. Interestingly, for each question the percentages of those who are not familiar at all or just not familiar are higher than 82%. The statistics shows that only 28 out of 517 respondents (5.4%) are very familiar about existence of Islamic financial services and their advertisement in Tatarstan. It is followed by the number of familiar respondents, who denote 12.4% only. Remaining figures are more significant with 38.1% of less familiar and 44.1% of those who are not familiar at all.

Table 2. Awareness towards Islamic Financial Products and Services Parameter Frequency Percentage Existence of Islamic financial services and their advertisement in Tatarstan Not familiar at all 228 44.1 Less familiar 197 38.1 Familiar 64 12.4 Very familiar 28 5.4 Contracts in Islamic finance: murabahah, mudarabah, musharakah, ijarah Not familiar at all 308 59.6 Less familiar 129 25.0 Familiar 44 8.5 Very familiar 36 7.0 Profit and loss sharing concept, investment in halal industry, no riba Not familiar at all 253 48.9 Less familiar 177 34.2 Familiar 55 10.6 Very familiar 32 6.2



4.3 Perceived Values Although the awareness level of the respondents toward Islamic financial products

and services in Tatarstan is low, the level of perceived values is considerably high. For instance those who believe that Islamic banks will play big role in poverty elimination encompass 39.5% of the total number of the respondents. Furthermore, 22.2% of the respondents strongly agree with the statement.

As for the statement of Islamic banks serving the low income community in Tatarstan, 108 out of 517 respondents (20.9%) strongly agree and 222 out of 517 respondents (42.9%) agree with it. The percentage of those who strongly disagree with this statement is the same with those who strongly disagree that Islamic banks will fulfil the banking need of Muslims in Tatarstan, and it equals to 5% only (26 out of 517 respondents. Nevertheless, majority strongly agree or just agree with the latter statement.

Table 3. Perceived Values regarding Islamic Financial Products and Services

Parameter Frequency Percentage I believe Islamic banks will play big role in poverty elimination Strongly disagree 23 4.4 Disagree 58 11.2 Neutral 117 22.6 Agree 204 39.5 Strongly agree 115 22.2 I believe Islamic banks will serve low income community in Tatarstan Strongly disagree 26 5.0 Disagree 60 11.6 Neutral 101 19.5 Agree 222 42.9 Strongly agree 108 20.9 I believe Islamic finance will fulfil the financial needs of Muslims in Tatarstan Strongly disagree 26 5.0 Disagree 49 9.5 Neutral 89 17.2 Agree 227 43.9 Strongly agree 126 24.4 4.4 Reliability Analysis

The reliability test was done using Cronbach’s alpha. From table 4.10,which shows the values of Cronbach’s alpha for every factor (latent variable) in theoretical model, it


can be seen that Cronbah’s alpha for all factors are above the minimum required value of 0.7.It indicates that all variables are reliable as it is recommended by Hair et.al. (2010). Based on the figures from the table below, the Cronbah’s alpha for respondents’ awareness, perceived values, attitude, subjective norms and intention are 0.865, 0.898, 0.909, 0.883 and 0.936 respectively.

Table 4. Cronbach’s Alpha Values for Every Factor Factor Number of indicators Cronbach’s Alpha Awareness (AW) 3 0.865 Perceived Values (PV) 3 0.898 Attitude (ATT) 4 0.909 Subjective Norms (SN) 3 0.883 Intention to Perform (INT) 3 0.936

4.5 Model Modification As can be seen from the Table 5, fit indices do not satisfy goodness-of-fit of the

model. The indices should satisfy the following conditions, namely χ2/df should be less or equal to 5.00; NFI, RFI, IFI, TLI and CFI should be more than 0.9; and RMSEA should be less 0.08. Therefore, there is a need for model modification.

Table 5. Fit Indices

χ2/df NFI RFI IFI TLI CFI RMSEA

22.025 0.704 0.652 0.713 0.662 0.713 0.202

For model modification, in order to obtain a better fitting for the hypothesized model, the approach provided by ‘IBM SPSS AMOS version 21’ can be used. Kline (2011) said that this approach can show us which path of covariance should be added or removed to improve the model fit. As suggested by the software, initially, double headed arrows of covariances between factors (latent variables) ‘Awareness’ and ‘Perceived values’, ‘Awareness’ and ‘Subjective norms’ as well as ‘Perceived values’ and ‘Subjective norms’ were added. These modifications showed positive effect on the model fit since χ2/df and RMSEA values decreased to 12.715 and 0.151 accordingly. Moreover, values of NFI, RFI, IFI, TLI and CFI increased to 0.834, 0.799, 0.845, 0.812 and 0.845 respectively. However, the indices showed that the model is still not well fitted.

Therefore, again double headed arrows of covariances were added between ‘e1’ and ‘e2’; ‘e2’ and ‘e3’; as well as‘e1’ and ‘e3’, to remove residual ‘e4’ as it caused high error in the model and could not be correlated with other residuals, and double headed arrows of covariances between pairs of unobserved variables ‘e8’ and ‘e10’; ‘e11’ and ‘e12’; as well as ‘e14’ and ‘e15’.

After all modifications, Table 6 shows the fit indices satisfied the following conditions, specifically χ2/df < 5.00; NFI, RFI, IFI, TLI and CFI > 0.9; and RMSEA < 0.08. Given that all indices values are statistically acceptable the modified measurement model is considered as the one to explain Islamic financial products and services patronizing behaviour in the Republic of Tatarstan taking into account the role of perceived values and awareness among people of Tatarstan.



Table 6. Fit Indices after Modification

χ2/df NFI RFI IFI TLI CFI RMSEA

3.841 0.957 0.943 0.968 0.957 0.968 0.074

4.5 Test the Hypotheses After the goodness-of-fit of the model is achieved, the model can be used to

evaluate the hypotheses developed in this research. The study has four hypotheses in total that are driven from previous literature. Table 7 shows the results of the hypotheses testing whereby, one can find the estimates, standard errors, critical ratios and p-values. It can be seen from the table that only two hypotheses are supported by the results of the model testing with p<0.05. While two hypotheses are rejected due to the fact that they were found to be not significant as p>0.05.

Table 7. Estimates of the Hypothesized Model

Structural Path Estimate Std. Error Critical Ratio p-value

Attitude <--- Awareness 3.724 0.815 4.568 ***

Intention <--- Attitude 0.03 0.066 0.45 0.65

Intention <--- Subjective Norms 1.32 0.082 16.124 ***

Intention <--- Perceived Values -0.119 0.051 -2.315 0.21

The findings indicate that only subjective norms have significant positive influence towards the intention to patronize Islamic financial products and services among people of the Republic of Tatarstan. This means that people are heavily considering the opinion or words of what people perceived important to them and put aside their own opinion or attitude towards the decision of whether or not they should patronize Islamic financial products and services. It is also proven that awareness regarding Islamic finance has a crucial influence on the attitude of Tatarstan people toward Islamic financial products and services. Nonetheless, this study discovered that perceived values do not play a significant role in behavioural intention in patronizing Islamic financial products and services in Tatarstan. In other words, perceptions that Islamic banks will play big role in poverty elimination, will serve low income community in Tatarstan or will fulfil the financial needs of Muslims in Tatarstan are not important in influencing their intention to patronize Islamic financial products and services. Therefore, similar to Abduh and Omar (2010) and Abduh and Omar (2012), it is recommended that Islamic financial institutions in Tatarstan to focus on providing quality Shari’ah compliant services compatible with conventional counterparts.

5. Conclusion Using modified TRA model, this study is aimed at examining the factors

influencing Islamic financial products and services patronizing behaviour in Russian Federation, particularly in Tatarstan. In terms of knowledge about Islamic finance it is interesting to note that more than a half of respondents have heard of Islamic finance. On the other hand, those who are not aware about Islamic finance denote 41% of the total number of the respondents. In addition, it is important to note that that ‘subjective norms’


is the key factor in intention to patronize Islamic financial products and services in Tatarstan.

Due to the lack of literature related to the area of the current study pertaining to Islamic financial products and services in Tatarstan, the present paper can be considered as a potential area for the new line of future research. As with all such studies, there are limitations that offer opportunities for further research. In view of the fact that the current study is the first on the topic of Islamic finance in the Republic of Tatarstan there are few limitations that include number of parameters of the hypothesized model, number of indicators (observed variables) as well as sample size. All the aforementioned elements can be improved further in next researches.

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Journal of Islamic Law, Management and Finance, Vol. 1 No.1, pp. 40-53. Abduh, M., & Idrisov, M. (2014). The Role of Perceived Values and Awareness upon the

Acceptance of Islamic Financial Products and Services in Dagestan. Journal of Islamic Banking and Finance, Vol. 31 No. 3, pp. 50-60.

Abduh, M., & Omar, M.A. (2012). Islamic-Bank Selection Criteria in Malaysia: An AHP Approach. Business Intelligence Journal, Vol. 5 No. 2, pp. 271-281.

Abduh, M., & Omarov, D. (2013). Muslim’s Awareness and Willingness to Patronize Islamic Banking in Kazahstan. Journal of Islamic Banking and Finance, Vol. 30 No. 3, pp. 16-24.

Ajzen, I., & Fishbein, M. (1980). Understanding Attitudes and Predicting Social Behavior. Englewood Cliffs: Prentice-Hall.

Bollen, K. A., & Long, S. J. (1993). Testing Structural Equation Models. Newbury Park: SAGE Publications.

Byrne, B. M. (1998). Equation Modeling with LISREL, PRELIS, and SIMPLIS: Basic Concepts, Applications, and Programming. Mahwah: Lawrence Erlbaum Associates.

Hair, J. F., Black, W. C., Babin, B. J., & Anderson, R. E. (2010). Multivariate Data Analysis (7th ed.). New Jersey: Prentice Hall.

Kline, R. B. (2011). Principles and Practice of Structural Equation Modeling (3rd ed.). New York: The Guilford Press.

Okumus, S., & Genc, E. G. (2013). Interest-Free Banking in Turkey: a Study of Customer Satisfaction and Bank Selection. European Scientific Journal, Vol. 9 No. 16, pp. 144-166.

Rammal, H. G., & Zurbruegg, R. (2007). Awareness of Islamic Banking Products among Muslims: The Case of Australia. Journal of Financial Services Marketing, Vol. 12 No. 1, pp. 65-74.

Razak, D.A., & Abduh, M. (2012). Customers’ Attitude towards Diminishing Partnership Home Financing in Islamic Banking. American Journal of Applied Sciences, Vol. 9 No. 4, pp. 593-599.

Schumacker, R., & Lomax, R. G. (2010). A Beginner's Guide to Structural Equation Modeling (3rd ed.). New York: Taylor and Francis Group.

Shaamirova, S. (2014). Public Perception on the Feasibility of Introducing Islamic Banking in Uzbekistan: Consumer Perspective. Unpublished Master Thesis, Kuala Lumpur: International Islamic University Malaysia.



Wider Access to Collateral-Free Financing and the Role of Waqf in Promoting Loss-

Profit Sharing Contracts By

Mohammed Mahmoud Mantai**

Abstract The purpose of this paper is to examine previous studies on the wider access to collateral-free financing in the context of Islamic micro-finance and entrepreneurs through the contracts of trust (Mudarabah and Musharakh) as well as assessing the role of the Waqf institution funds in their facilitation. We find that majority of the previous studies investigated propose the provision of collateral-free financing to the poor and the entrepreneurs and suggest the participation of the Waqf institution but unfortunately there is no specific model developed so far. Therefore, in this paper, we attempt to propose a new model in which Islamic banks can offer collateral-free financing with collaboration with the Waqf institution through the Profit and Loss sharing contracts.

Key Words: wider access, collateral-free financing, waqf and proft-loss sharing contracts

1. Introduction

Since the 1970s, collateral-free microfinance has been the major tool of promoting inclusive growth and sustainable development (Bapat, 2015). However, as cited in the same paper, it was said by (Peet and Hartwik, 2009) “ to develop as a society, as a country, as a race means to change the world for the better, to make life better for everyone and most importantly to sow the seeds of change at the bottom rather at the top.” Moreover, it was cited by Sabur and Uddin (2013) that The Secretary General of the United Nations declared 2005 as microcredit year for microfinance institutions (MFIs), however, in the article it is mentioned that lending to poor households is doomed to failure as the costs are too high, risks are great, saving propensities are too low, and few households have much to put for collateral, and they argued academically that higher cost * Author: Mohammed Mahmoud Mantai, INCEIF- The Global University of Islamic Finance,

Kuala Lumpur, Malaysia


of borrowing may prevent poor borrowers from rising above the poverty level. Nevertheless, the World Bank (WB) has given a great deal of attention to financial inclusion (FI) as one of the crucial issues due to its importance in reducing poverty and inclusive economic growth (Asli Demirguc- Kunt, 2014). However, according to the WB report, FI is considered as a means to an end. Moreover, evidence from research has shown the participation of the people in the financial system largely contributes in the business expansion, investment in education, risk management and the absorption of the financial shocks. Furthermore, the report documents that wider access to financial services at the level of individuals and firms may lead in the reduction of income inequality as well as to an economic growth enhancement. Hence, in 2011, the WB has launched the global financial inclusion (Global Findex) database that constitutes a number of indicators that show how people around the globe save, borrow, make payments and manage their risks. Surprisingly, as it is mentioned in the Global index, in 2014 the percentage of adults that has been reported to have borrowed money from banks or other sources within the period of 12 months excluding credit cards were 42 percentage. FI is an elusive and very narrow Global index, in our point of view, despite its contents as a result of its superficial assessment of FI and the lack of inclusion of wider access to collateral and /or collateral-free financing. Nevertheless, this is in consistence with the findings of (Sinclair, 2013) about the continuing problems of access to main stream banking service for low income customers and the lack of appropriate and affordable credit provision. Meanwhile, the author based on his studies results strongly suggest the indicators of the financial inclusion to be defined particularly with access to financial services.

Therefore, FI is an unrealistic measure of inclusion because it is only appropriate for those who have money but they do not have bank accounts or for those who have real assets as collateral and they borrow either for consumption or investment to maximize their wealth. Hence, the claimed inclusion is only partial and the majority of the global population is still in exclusion, particularly, in the developing countries including the enthusiastic entrepreneurs and the poor.

In fact, the objective of this paper is to critically examine the obstacles, challenges and the proposed feasible options in literature under the scope of the Islamic finance microfinance from the perspective of collateral-free financing and the implementation of the two most core Islamic modes of financing – Mudarabah and Musharakah. Moreover, in this paper we attempt to propose a new theoretical model that incorporate Waqf and the two core modes of financing as a durable solution to most of the obstacles and challenges that hinder the collateral-free financing and thereby leads to true financial inclusion, equitable distribution of income and wealth as well as balanced socio-economic development and prosperity. Meanwhile, this paper while it supports the proposed model of project financing by (Soumaré, 2007) it, however, refutes the participation of the government due to the political risk, its impact on market efficiency and the overall financial instability. The objective of the profit-loss sharing is not only to getting access to collateral-free financing but to strengthen the societal solidarity and to inculcate mutual cooperation and trust. Nevertheless, the proposed model is completely unviable in developing countries with corrupted governments, instable economic growth, uneducated citizens and underdeveloped financial system. Meanwhile, our study is in agreement with the conclusion of (Waheed Akhter, 2009) that interest free loans can be used as a powerful tool against poverty with the integration of Islamic micro-financing with the institutions of Zakat and Waqf.

Wider Access To Collateral-Free Financing And The Role of Waqf……….


This study is expected to contribute significantly in three main dimensions: Firstly, the involvement of the Waqf institutions in the financing scheme will facilitate financing through Mudarabah and Musharaka by mitigating their respective risks that cause the financial institutions to shy away from them including Islamic banks. Meanwhile, the promotion of these modes of financing will certainly have a positive impact on the revitalization of the Awaqf through cash Waqf and the Waqf share revenues. Secondly, this study is different from other current studies that discuss the role of Waqf in financing microfinance as a solution to poverty alleviation. Thirdly, this study having given the opportunity of implantation, it is expected to contribute in the enhancement of trust, solidarity, wider access to collateral-free financing, healthy economic growth and financial stability.

The remainder of this paper is organized as follows: in section two, we critically investigate the existed literature such as in the role of Waqf, the challenges and benefits for Islamic banking in the implementation of Mudarabah and Musharakah contracts. Whereas in section three we present the used research methods and in section four we discuss in detail the core Islamic modes of financing including the Mudarabah and Musharakah contracts; collateral-free financing and Islamic micro-financing; the role of Waqf in promoting the profit-loss sharing contracts and their socio-economic impacts. Finally, we precisely discuss the conclusion of the study.

2. Literature Review Literature documents how interest rate (riba) leads to concurrent global economic

and financial crises that consequently affect societies in the form of extreme income disparity, unjust transfer of wealth, crimes, poverty and other social illnesses. Iqbal (2010) evaluated the prohibition of interest and economic rationality and he argued with two main reasons, first, he said that riba leads to the exploitation of poor masses by the rich minority, and second, it results in unfair distribution of actual profits between the lenders and borrowers. Furthermore, he emphasized that the negative externality of debt financing is extremely devastating during economic bad times and its prohibition rather than permissibility makes more economic sense. This could be more practical if financial institutions shift from debt financing to collateral-free financing. As it is argued by (Halabi, 2006) that though Islam prohibits the imposing and receiving of riba, it encourages sharing of profits and risks either in banks or any business venture. However, loans should be advanced when lenders and borrowers share the profit and loss together.

In today’s world of dominant conventional financial system, financial institutions to advance loan, have to do a great deal of investigation in order to avoid credit risks and borrowers’ default. Hence, conventional financial institutions including banks can only provide loans to those who have high credit rate and sufficient collateral property which simply means a clear bias towards those operating in the corporate world and not the poor. Unfortunately, Islamic banking institutions are also imitating their conventional counterparts due to some (unreasonable) theoretical reasons. However, this kind of risk aversion towards micro-financing by the banking system and its financing modes through interest and other similar modes discourage entrepreneurs to embark in profitable businesses and keep the economy in permanent crises. In his studies about the challenges and solutions in Islamic microfinance (Dean, 2013) clearly confirmed the lack of fund mobilization which shows the lack of banks participation in the financing process. Moreover, it was recommended the technical assistance to be through Waqf and Zakah funds. Salle (2015) has studied the role of Zakat institution and the integrating of


financial inclusion and savings and he took financial inclusion as a proxy of financial needs due to the importance of reflecting the reality of the poor and the destitute. However, he argued creating an enabling environment for these groups will help them escape from poverty and uplift their well-being. However, the author has mentioned among the eight types of Zakat disbursement for the poor and destitute in Brunei, the entrepreneurial assistance in the form of the provision of financial capital and physical goods such as tools and machinery whereby Zakat recipients and low-income households who were lacking creditworthiness are able to obtain financing for their small business through the zakat disbursements or attain credit via al –Rahan facility.

The Islamic micro finance (IMF) as a collateral-free mode of financing was also studied in the European perspective as a key role in poverty alleviation. Sabur and Uddin (2013) found that IMF can be adopted without compromising shariah compliance. They also suggest the zakat and Waqf funds to provide training and loans to significantly reduce poverty. The author furthermore highlighted that there are 125 IMF that operates in 19 Muslim countries, and use the models of Mudarabah, Musharakah and Murabaha. They also documented that IMF projects began in Sudan in the 1980s using the Mudarabah and Qard al-hasan products. Meanwhile, while Yemen and Iran use Musharakah and Qard al- Hassan products respectively, Malaysia implements Bai Bithaman Ajil (BBA) and the Mudarabah concepts. According to (Rahman, 2010) the participatory schemes such as Mudarabah and Musharakah have great potentials for microfinance because of the satisfaction of the risk sharing needs of the micro-entrepreneurs and the ethical attributes that effectively motivate them to thrive. In the case of home financing, (Hasan Z. , 2011) evaluated the efficacy of the existing popular home financing modes of ; Musharakah Mutanaqisah partnership (MMP) and proposes a new mode called Diminishing Balance Model which is comparatively easy, transparent and cheaper relative to the conventional interest-based instruments. Moreover, he mentioned that in the case of rental and the prices of the bank-share- units, the bank is likely to have the upper hand, to the advantage of the ill-informed and need- pressed client. Finally, we conclude the nexus between Islamic banking and microfinance with the insightful analysis of (Sapcanin, NA) who said that many of the elements of instruments are consistent with the broader goals of Islamic banking as both systems advocate entrepreneurship and risk sharing, and the belief that the poor should take part in such activities. Hence, the access to collateral-free loans is the realistic example of how Islamic banking and microfinance can share common goals. Moreover, they have described the close relationship that not only would provide obvious benefits for the poor entrepreneurs but also would give investors in Islamic banks an opportunity to diversify and earn handsome profits.

As a novel mode of financing, the profit-and-loss sharing contracts of Mudarabah and Musharakah have gained the attention of many researchers. Michel et.al. (2005) mentioned that the adaptation of the profit sharing plan (PSP) is a clear reflection of a performance-driven managerial strategy that evolves into innovation and long-term value creation. Furthermore, they have found four key findings such as a strategic business units within a large financial services have more propensity to adopt a PSP if they exhibit large asset size and superior growth which could be translated to earnings growth. Furthermore, the adoption of PSP boost higher growth and leads to innovation and greater improvement in performance. Another scholarly paper on the entrepreneurial role



of profit-and- loss sharing modes of finance in theory and practice by (Kayed, 2012) argued that there is no evidence that shows that Islamic banks have provided venture capital or financed small and micro enterprises. Thereby, the author argued the failure of Musharakah is due to the attitude and the behavior of the Islamic financial institutions and their reluctance to accommodate entrepreneurship through the genuine implementation of PLS contracts. In the so far discussed literature, Islamic banking has deliberately ignored the PLS mode of financing in order to avoid their high risk despite the acknowledgement of their profits. However, (Ahmed G. A., 2008) has discussed the implication of using profit and loss sharing modes of finance in the banking system in Sudan. Interestingly his results have shown high preference of Musharakah among banks staff compared with other modes of finance, and attributed the significant lack of the PLS projects due to the lack of the knowledgeable bankers in selecting, evaluating and managing profitable projects. The author further illustrated that the Musharakah contract did not need any collateral and therefore does not leave the entrepreneur or partner under heavy burden of debts or any form of obligation compared to its conventional counterpart. Meanwhile, the author highlighted that almost one-third of the total fund have been financed using Musharakah in the Sudanese banking industry. The significant role of the Musharakah mode of financing has also being shown its viability in the project financing through sukuk. In the 2006 – 64 RM sukuk that were issued in Malaysia valued at RM 42.02 billion; RM 29.4 billion (70.0%) based on Musharakah followed by Mudharabah RM3.9 billion (7.5%) with a tremendous value growth of (435%) in 2006 as compared to 2005, which is a clear indication for project financing (Ghani, 2007).

For the poor to get access to a collateral-free financing through the profit –and- loss sharing contracts, as discussed above, a vast number of studies has suggested the involvement of Waqf, Zakat and even the government due to the reluctance of Islamic banking. Mohsin (2013) study has shown the potential of cash waqf beyond the religious programs, it could be utilized in financing the necessity goods and services that are needed in the society and creation of more jobs opportunities. In assessing the integration of waqf-Islamic micro-financing through an empirical model (Mohamed et.al. (2015) found a result that indicates the possibility of eradicating poverty through Waqf besides the provision of educational and training programs to the borrowers. A similar study by (Sadeq, 2002) also confirmed the possibility of poverty eradication through Waqf by the provision of educational, medical and physical and infrastructure facilities and utilities. Meanwhile, the author emphasized the achievement of the goal requires a capable and committed administration with strong leadership personalities. Meanwhile, (Azliza Azrah, 2012) argued that, the participation of the Waqf institution besides providing financial subsidies, enhances business values and creates positive social impacts. Further studies extended the role of Waqf in financing the small and medium enterprises (SMEs), and in this regard, (Hasan S. , NA) developed a model for Singapore SMEs under the auspices of the Islamic Religious Council of Singapore. The proposition of the model was due to the only single Islamic bank i.e. Maybank Singapore which covers products that did not involve direct contact with ‘micro and small entrepreneurs despite the high employment rate (6 out of 10 workers) and a total of 46% value added to the economy. However, a similar model was proposed by (Ahmed H., 2007) but to provide microfinance to the poor entrepreneurs as well as to reduce the financing costs and improve the viability of the microfinance institutions.


3. Research Methodology

Poverty is the biggest issue that the world has failed to alleviate despite the development in the financial system and unprecedented technological advancement. The idea of giving loans in different nominations and to different projects have also shown to be infeasible. However, the rebirth of Islamic finance and its financing instruments have got great attention from both academicians and policy makers as an alternative to the existing conventional modes of financing to eradicate poverty and to offer collateral-free financing. Nonetheless, though majority of the studies have shown the viability of the Islamic methods of financing, the Islamic banking system is yet not ready to embrace them due to a bunch of reasons such as higher risk and customer creditworthiness … etc. In addition, majority of the Islamic banking institutions have focused more on modes of financing that mimic their conventional counterparts. Nevertheless, in order to counteract this type of risk transfer financing and to persuade the banking sector to adapt fully the risk sharing mode of financing, there is a great need to develop viable Shariah -compliant Islamic instruments that are supported by the public institutions and approved by the government. Therefore, the employed methodology in this paper is the survey and examination of past studies, and proposes a new model that may facilitate the issue of accessing collateral-free financing and contributes, as well, in the promotion of the profit-loss contracts. This model incorporates the participation of the Waqf institution with the Islamic banks in the financing process so that the poor and the entrepreneurs who do not have collateral can get access to financing without difficulties to start their businesses.

The proposed model below is expected to facilitate the collateral-free financing by Islamic financial institutions as well as to boost the risk and profit sharing contracts. The involvement of the Waqf fund through X% using Mudarabah and Y% using Musharakah will mitigate the risk that the Islamic banks would take by assuming a portion of it which is equivalent to their contribution. Furthermore, the Waqf fund may generate some cash Waqf in the realization of profit and this will also contribute in the development of Waqf. The wider access to collateral-free financing through this model will promote the idea of entrepreneurship and risk sharing among the poor, and will instill further the Islamic core values of solidarity and cooperation.

Figure 1: The Proposed Model

Source: The researcher

100% -X%

Mudharabh

100%

X%

Waqf dIslamic Poor Y%

100% -Y% 100%

Musharaka



4. Profit-loss sharing contracts and their socio-economic impacts Eradication of poverty has become a major problem at both regional and global

levels. All governments, national and international institutions such as the International Monetary Fund (IMF) and the WB have all attained little success in eradicating poverty, particularly in the developing countries. The main reason is the debt mode of financing that exacerbates the situation of abject poverty. The WB and the IMF give loans based on certain conditions to governments who channel 90 percent of them to buying ammunitions and expend the rest to some development programs. However, the banking system can only provide loans to those who have collateral whereas the bigger part of the population who do not have such collateral are denied access to financing.

Nonetheless, the rebirth of Islamic finance and Islamic banking was expected to bring a durable solution by offering wider access to collateral-free financing through the true modes of financing, i.e. profit and loss sharing contracts. Some may argue that Islamic banks are still nascent to assume the profit and loss modes of financing due to the risks that are associated with such contracts. Meanwhile, others also argue strongly that the aim of Islamic banking is not only to maximize profit but to play an important socio-economic role through the PLS contracts that can protect them from the injustice of conventional institutions and safe-guard them from the consequences of riba financing. It is evident that Islamic banks do not normally lend money except interest –free loans in the form of Qard al-Hassan. Therefore, in order to abolish interest, Islamic banking must implement their ideal modes of PLS financing. The Mudarabah contract in Islamic banks can operate with so many agents at the same time both as working partner and as an investor whereas in Musharakah the Islamic bank shares the loss with its partner based on their capital contribution. Indeed, this PLS mode may pose some serious risks and moral hazards to Islamic banks due to the wide-spread tendency of adopting unethical accounting practices to conceal true profits , high rate of illiteracy and host of other reasons which are beyond the control of the entrepreneur. However, PLS financing shifts the debt based transaction to investment based financing. Moreover, PLS may generate higher returns, absorbs the impacts of inflation and recession, and it leads to optimal allocation of resources for the overall economic growth and welfare of the society at both levels individually and collectively.

Farahbaksh and Errico (1998) has deeply analyzed the Islamic modes of financing. However, in this we include and discuss their analysis. Interestingly, they have named Mudarabah as trustee finance contract and Musharakah as equity partnership contract. The authors mentioned that while Mudarabah is used in the investment of short period as well as in financing trade and commerce, Musharakah is employed to finance long-term investment projects. However, they also highlighted the request of collateral to help reduce moral hazard and prevent the entrepreneur from running away. Meanwhile, they have stressed the absolute freedom of the entrepreneurs to manage their business. However, in the case of Musharakah, all invested parties have the right to participate in the management of the enterprises but profit (and loss) are shared strictly in relation to the respective capital contribution. Nevertheless, our stance, as long as the contract is built on trust, there should not be any form of collateral; neither implicit nor explicit. Meanwhile, in the innovative two-tier Mudarabah model in which the assets and liabilities of the bank’s balance sheet are fully integrated, the Islamic banks may grant short-term interest-free loans which are very commendable due to their role of offering collateral-free financing.


PLS contract is not merely a financing mode, it also play a significant socio-

economic role. One of its main advantages it avoids the fragility endowed in pure debt (or even the traditional Islamic debt facilities of Murabaha, Tawarruq) and Qard al- Hassan. Hence, it enhances the robustness of the financial system, and is also consistent with the Quranic injunction of assisting borrowers at the times of difficulty. Meanwhile, it has a number of benefits such as resolving the problem of adverse selection and it allows investors to retain control of the firm. Furthermore, the Musharakah mode of financing encourages Muslim entrepreneurs to engage in some innovative projects which lead to the real economic growth and sustainable development. Moreover, these modes of financing besides providing access to the collateral-free financing which improves the economic situation of the poor and the entrepreneur, they also help in strengthening the solidarity and trust among the Muslim society and others with different faiths.

5. Conclusion Despite the persistent global efforts in the eradication of poverty, there is still half

of the world population in dire poverty. The main reason is because of the lack of access to collateral-free financing. Most of the national and international financial institutions offer loans with interest and demand collateral as a guarantee. Majority of the poor people and entrepreneurs either do not have capital assets to pledge or they do not want to borrow with interest rate due to its prohibition. Thus, they all remain unproductive and become forced victims of poverty. This paper is a serious attempt in investigating previous studies of Islamic micro-finance and its modes of financing, examining the implementation of profit and loss sharing instruments and the role of Waqf in the facilitation of collateral-free financing and the enhancement of the profit and loss sharing contracts. In the examined studies there is much support for the provision of the wider access to collateral-free financing and they suggest the involvement of Waqf. Nonetheless, there is no suggested model. Therefore, in this paper, we propose a new model in which both Islamic banks and Waqf institutions can effectively collaborate in offering the collateral-free financing to the productive entrepreneurs and the poor through the contracts of trust (Mudarabah & Musharakah).

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Sinclair, S. (2013). Financial inclusion and social financialisation: Britain in a European context.

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Poceedings 2nd CBRC, (pp. 1-8). Lahore: Research Gate.


Shariah Appraisal of the Takaful Model Based on ‘Tabarru’ (Donation)

Farrukh Habib* Mughees Shaukat**

Abstract The perception of donation (‘Tabarru’) is one of the basic elements in most of the composition of Takaful models. It intends not only to facilitate the modern Takaful structures from an Islamic law perspective, as it immunizes these structures from prohibited factors; but also to promote the noble concept of Islamic law of contracts, which is risk sharing among the participants of an Islamic financial system, or of a Takaful scheme for that matter. However, in current Takaful practices, the notion of ‘Tabarru’ is quite vague and controversial. It is argued that the concept of ‘Tabarru’ has been implemented while following only the letters of the Islamic law, but not the spirit. In order to support such practices, some dubious and perplexing explanations have been utilized; making the whole structure of such Takaful models questionable. This study critically examines the ‘Tabarru’ based models of Takaful; our analysis shows that the present practices of ‘Tabarru’ based Takaful models, renders it more in violation of Shariah ordainments than in compliance to them. Such deviations lead to an increasing absence of risk sharing in finance; a necessary requirement of an Islamic economic system. Therefore, it is suggested that the ‘Tabarru’ structure, as implemented today, needs to be re-examined and reformed on the basis of the concept of risk-sharing.

Keywords: Takaful, donation (Tabarru), Shariah Appraisal, Risk sharing.

* Farrukh Habib is a Research Officer at International Shari’ah Research Academy (ISRA) and

PhD candidate in Islamic Finance in INCEIF, Kuala Lumpur Malaysia. E-mail: [email protected]. ** Mughees Shaukat is Head of Islamic Finance in College of Banking & Financial studies,

under Central Bank of Oman. Muscat, Oman and a PhD Scholar in Islamic finance, in INCEIF & ISRA, Kuala Lumpur, Malaysia. E-mail: [email protected].


1. Introduction The epistemological root of risk sharing, as the organizing principle of the Islamic

financial system, is discernible from chapter 2, verse 275, of the Quran. This verse, in part, decrees that all economic and financial transactions are conducted via contracts of exchange (al-bay’) and not through interest-based debt contracts (al-Riba). It can be argued that risk sharing – the crux of Islamic finance – serves as one of the most important distinction of Islam i.e. the unity of mankind. Since in the verse, the contract of exchange appears first and the prohibition of Riba thereafter, it can be argued that requiring contracts to be based on exchange constitutes a necessary condition and “no-Riba”, the sufficient condition of existence of an Islamic financial system. Together, these conditions constitute the organizing principle of that system (Mirakhor and Shaukat, 2012, 2013). The necessary condition (al-bay’) and sufficient condition (no Riba) must be met for a contract to be considered Islamic (Mirakhor, 2011b). However, there are other rules that provide the supportive scaffolding in order for the pure implementation of the verse 276 of chapter 2. Central among the rules that constitute the full institutional framework of an Islamic economic system, alongside the application of sharing risks and no Riba, are rules governing:

Full and transparent observance of Property rights. In Islam, there are only two ways in which the individuals can gain legitimate property rights. Individuals can gain property rights through a combination of their own creative labour and other resources or through transfer—via exchange, contracts, grants or inheritance—from others who have gained property rights title to an asset through their own labour (see chapter 53 verse 40; chapter 17 verse 26; chapter 24 verse 22; chapter 30 verse 38; chapter 4 verses 11-12). Fundamentally, therefore, work is the basis of acquiring rights to the property1. The rules governing property rights forbid instantaneous property rights claim without commensurate work. The exception is transfer via gifts from other who have gained legitimate property rights claim on the asset transferred. The prohibition covers theft, bribery, gambling, interest from money lent, or, generally, income and wealth obtained from sources and activities not permitted by Shariah (see for example chapter 5, verse 38; chapter 2 verse 188 and 275; chapter 5, verse 90 in Holy Quran).

Faithfulness to terms and conditions of contracts. Islam forcefully anchors all social-political-economic relations on contracts. More generally, the whole fabric of the divine law is contractual in its conceptualization, content and application. Its very foundation is the primordial covenant between the Creator and the humans (Mirakhor, 2011a) [see chapter 7 verses 172-173]. The covenant imposes the obligation on humans to remain faithful to its affirmations that they recognize the supreme Creator as its Cherisher Lord. In verse 152 of chapter 6, the Quran urges the believers to fulfil the covenant of

1 The concept of work in Islam (called ‘amal) is far broader and has different characteristics

and objectives than that understood in the Western economic tradition. In Islam, work ethic is defined by the Quran itself, which mentions the word ‘amal in 360 verses. A closely related concept of fi’l (also translated as work) is mentioned in an additional 109 verses. All these verses stress the need for work and action by human beings (Islamreligion.com, accessed on 10, August, 2013 at 15:45).


Allah. This is extended to the terms and conditions of all contracts through another clear verse of chapter 5, verse 1 in which believers are ordered to be faithful to their contracts. They are ordered to protect faithfulness to their covenants and what has been placed in trust with them as a shepherd protects sheep (see chapter 23, verse 8; also chapter 17, verse 34; chapter 2, verse 2; chapter 16, verse 91-92; chapter 3, verse 61). So much so that the Quran has dedicated the longest verse on the importance of contracts and their fulfilment (see chapter 2 verse 282), thus believers do not treat obligations of contracts lightly. They will take on contractual obligations only if they intend fully to fulfil them2. Hence, their commitments are credible (Mirakhor, 2010).

Shariah approved sources of factors and products before they enter the market;

Provision of full information regarding qualities, quantities and prices of factors of production and product to all buyers and sellers—before the start of price bargaining process;

“There is no ‘Ghash’ meaning there should not be any kind of misrepresentation of the product.

No Gharar and ‘Maisir’ and a strict prohibition of speculative activities;

Full and transparent information”. Everything about the product must be known and nothing should be hidden. Anyone who enters the market is informed fully of prices and products.

As well as rules on distribution and re-distribution. This is in consideration of the inequalities that are created due to the fact that some members of the society may be physically or otherwise unable to access resources to which they are entitled to as per the property rights rules of Islam (see chapter 6 verse 165; chapter 43 verse 23; chapter 16 verse 71). The inequalities could also arise due to the presence of the idiosyncratic risks which when materialize play havoc with people’s income and wealth (Mirakhor and Shaukat, 2012; Mirakhor et al., 2012. 2013 and Mirakhor and Shaukat, 2013). The most important economic institution that operationalizes the objective of managing any ensuing inequalities is that of the distribution/re-distribution rule of Islamic economic paradigm. For example, the Mechanism for redeeming the rights of the less able in the income and wealth of the more able are the network of mandatory and voluntary payments such as Zakat (2.5% on wealth) and payment referred to as ‘Sadaqat’ (see chapter 9, verse 60; chapter 22, verse 41; chapter 2, verse 110, 261; chapter 34, verse 39; chapter 57, verse 18; chapter 73, verse 20).

2 This has implication for the cost and efficiency of transactions as it eliminates

informational problems as well as moral hazards and adverse selection (see Mirakhor, 2011a: b).

Sharia Appraisal of the Takaful Model based on ‘Tabarru’


From the above, it can hence be summarized that the institutional framework of the Islamic economy is composed of a collection of institutions−rules of conduct− to deal with allocation of resources, production and exchange of goods and services, and distribution/redistribution of resulting income and wealth. The main objective of these institutions is to achieve social justice and unity alongside economic prosperity. Important among their functions is the reduction in uncertainty for members of the society in order to allow them to overcome the obstacles in decision making caused by paucity of information. Rules specify what kind of conduct is most appropriate to achieving just results when individuals face alternative choices and must take action. They impose restrictions on what the society’s members can do without upsetting the social order on whose existence all members count. This also helps them in deciding on their own actions and forming their expectations of other’s responses and actions when in situation of uncertainty or facing risks.

Risk and uncertainty are undeniable facts of life. Uncertainty stems from not only the lack of information but also from ignorance of knowing the response and behaviour of others under such conditions. The question arises as to why risk and uncertainty exist. This question becomes more acute for those who believe in the Supreme Creator of all things. Since it is believed that existence of risk and uncertainty is a source of difficulty for humans, a Creator-centric question also arises: why create risk and uncertainty for humans? Bartholoemu (2008: 230) argues that “a plausible argument for the necessity of risk is that it serves as an important ingredient in the recipe of full human development. It provides the fertility and diversity of experience to develop our skills and personalities.” The Qur’an, on the other hand, provides a more compelling explanation: humans are subjected to tests throughout their lives to allow them a sense of degree to which they, individually and collectively, are rule compliant (see for example, chapter 2 verse 155; chapter 7, verse 130; chapter 76, verse 2; chapter 29, verse 2; chapter 9, verse 126; chapter 11, verse 7 in Holy Quran). Without risk and uncertainty, testing would not be possible (Mirakhor, 2009 and Mirakhor and Shaukat, 2012, 2013). To ease the intensity of anxiety in dealing with tests and, therefore, reduce uncertainty and demand on humans’ cognitive ability, compliance with the behavioural rules prescribed by Quran as well as sharing the risks, help reduce economic risks and uncertainties while guaranteeing a prosperous socio-economic order (see chapter 7 verse 96). “A careful consideration of all the permissible contract modes that have reached us reveals them to be basically risk sharing contracts. The instruments designed to financially empower them must also be risk sharing instruments” (Mirakhor, 2010, 2011a, b).

It can hence be asserted that in Islamic economics and finance, theories and practices cannot afford to be indifferent from the framework of Shariah acquiescence. The case of Takaful industry, as part of the same Islamic system, is not different from it. The industry has to be compliant with Shariah principles, while remaining competitive in the insurance market. The contention of the present study is to try and do a Shariah appraisal of the given model of Takaful as practiced in Malaysia. Although the Takaful scheme was first set up in Sudan in 1979, followed by UAE in 1980, However, Malaysia was fast to catch up. Formally adopting it in 1984 with the instigation of Malaysian Takaful Act, the market has shown an implausible growth since then. For instance, the


Malaysian Takaful contributions in 2008, 2009 and 2010 grew at 27%, 30% and 24%, respectively.3 Family Takaful contributes 77% of Malaysian market with a very high market penetration rate, while the remaining 23% of the market is covered by general Takaful.2 Malaysian Takaful industry is considered more matured and developed as compared to the Takaful sector in other countries of the world.

This exceptional performance, however, has raised some concerns, as there is always a trade-off among priorities; not all the goals are achievable. The upside of the situation is the growth, performance and expansion of the industry; and the downside is that the practical part seems to be losing its ties with the theoretical basis. It has been implied by many scholars from time to time that the gap between the notional Takaful structures proposed by the Shari’ah and the practices of the industry has to be abridged. Otherwise, it is feared that the whole Takaful system will become prone to the same attributes (i.e. Riba, Gharar, Maisir, etc.) which have already been inhabited in conventional system.3

The study is divided into VI sections. The following section II while giving the definition of ‘Takaful’ will briefly discuss the model of Takaful; one that is based on the concept of ‘Tabarru’. Supported by the views of the prominent schools of thought, the concept of Tabarru is then discussed under the perspective of Shariah, followed by the ensuing axiomatic features and its legal status; the subject of section III. Section IV will give a brief account of the current practice of the given model and its application in the Malaysian context. Section V provides the all-important Shariah appraisal of the Malaysian Takaful practice and pinpoints some important deviations; rendering the Tabarru based Takaful model in violation of some essential Shariah ordainments. Crucial among these deviations are the violation of the Islamic rules in relation to transparency of Property rights, clarity in the nature, terms and conditions of contracts, alongside the presence of ‘Riba’, ‘Gharar’ and ‘Maisir’ to say the least. This is in turn leads to an increasing absence of risk sharing—the chief characteristic of an Islamic financial system. We conclude the study in Section VI with some recommendations.

2. The concept of Tabarru in Takaful The word “Takaful” (تكافل), an Arabic word, is derived from the root word “al-

Kafalah” (الكفالة), which means “guarantee” or “responsibility”; hence, Takaful means “to guarantee each other” or “to share responsibility”.4 Another meaning of al-Kafalah is indemnity; so, in that sense, the word “Takaful” stands for “mutual indemnity” or “to indemnify each other”.5 In the modern context, Takaful is used for the Islamic alternative system of conventional insurance. In other words, Takaful is Shari’ah compliant way of doing insurance. Similar to the conventional insurance, it also offers both life and general insurance coverage.6 Malaysian Takaful Act (1984) defines “Takaful” as:

3 Takaful Re (2012) 2 World Takaful Report (2011) 3 Ismatullah (2009), p. 83-87. 4 Ismatullah (2009), p. 72 5 Rabiah and Scott (2008) 6 IFSB and IAIS (2006)



Takaful is a scheme based on brotherhood, solidarity, and mutual assistance which provides for mutual financial aid and assistance to the participants in case of need, whereby the participants mutually agree to contribute for that purpose.7

Another definition of Takaful system may be given as:

Takaful means, mutual guarantee provided by a group of people living in the same society against a defined risk or catastrophe befalling one’s life, property or any form of valuable things.8

It can be inferred from the above two definitions, that Takaful is a benevolent way to assure the participants (policyholders) who agree to help each other against a stipulated risk.9 Another point to be noted is that Takaful, unlike insurance, provides the opportunity of risk sharing, instead of transferring or shifting it to other parties. Even the Takaful operator, which provides Takaful services, acts merely as a manager of Takaful funds; it does not assume any responsibility of indemnification.10

Given above the definitions of Takaful, it can be safely inferred that the backbone, on which the whole structure of Takaful stands straight (particularly in case of Malaysia), is the idea of Islamic donation (al-Tabarru, التبرع). The incorporation of the concept of Tabarru in Takaful system protects the contract from the proscribed impact of uncertainty (al-Gharar, الغرر) which is the focal cause for the conventional insurance being non-Shariah acquiescent.11 This is because of the fact that, since it is a unilateral charity contract, the uncertainty is tolerable. Many contemporary studies on Takaful describe the Takaful structure by explaining the relation between the joint contribution pool (the Takaful Fund) and the Takaful operator. When they elucidate different models applied in Takaful, i.e. Wakalah (الوآالة), Mudaraba (المضاربة), hybrid of both, Ju’alah (الجعالة), etc., they, in fact, talk about the relation between the Takaful fund and the operator. However, more importantly, the exact status of the Takaful fund regarding the participants should be clarified prior to that issue; because, the implications of the real status of the Takaful fund, in connection with the participants affects all further proceedings. The concept of Tabarru which facilitates the building of Takaful fund must not only be understood lucidly, but also be applied without losing any characteristic explained by the theory of Islamic law. Thus, this research paper examines the idea of Tabarru in details within the framework of Shariah, and compares it with the current practices in Malaysian Takaful industry. The study intends to locate the divergences between the Shariah rulings related to donation (Tabarru) and the current implemented model. It is argued that the current practice of Takaful in Malaysia, based on the model of Tabarru, is lagging far behind in fulfilling the Shariah ordainments in relation to the economic rules, required to align Takaful transactions with the Islamic law of contracts. After all, the fulfilment of the prescribed rules justifies the very existence of an Islamic economic system as well as its subs systems.

7 Rabiah and Scott (2008) 8 Billah (2007), p. 18 9 IFSB and IAIS (2006) 10 Bakar (2009) 11 Yusof (1996); Arbouna (2008), p.217-218


3. The Concept of Tabarru from Shariah Perspective

The lexical meaning of Tabarru:

It is a charity which is given without being asked, and which does not oblige the person taking the charity to compensate in return.12

Tabarru is a broader term as compare to Sadaqah and Hiba constituting all charitable donations.13 Sadaqah is a form of charity in which the direct intention of the donor is to seek Allah’s pleasure; while, in Hiba, the expressed objective of the donor is to seek people’s contentment.14 A specific form of Hiba is Hadiya. If the gift-giver transfers the gift to the receiver showing respect to the receiver, it is called Hadiya (هدية). For example, if a person of lower status presents a gift to a person of higher rank as a gesture of admiration, it is Hadiya. Some scholars opine that Hiba is a wider term constituting both Sadaqah and Hadiya.15 So, Tabarru is correspondent to Hiba (هبة, gift), because their rulings are same, and the Islamic scholars use these terms interchangeably without any reservations. Hence, these two terms (i.e. Hiba and Tabarru) are equivalent.16 In order to completely comprehend the idea of Tabarru (or Hiba), it is pertinent to define it from the standpoints of all four famous schools of Islamic legal thought.

3.1 Donation (Tabarru): Defined by the Prominent Schools of Thought Below we discuss the most popular definition of Tabarru from four famous schools

of Islamic law. In order to observe brevity, only those definitions which are officially adopted by these schools of thought are discussed.

3.1.1 THE VIEW OF HANAFIS One definition is given by the Hanafis as:

Hiba (Tabarru) is to give the ownership of property to another, without reward.17

The same definition is provided by Ibn Abidin (Hanafi), as:

Hiba (Tabarru) is to make someone owner of the corpus of property without any consideration.18

3.1.2 THE VIEW OF SHAFIS Al-Nawawi (Shafi) states that:

Making someone the owner of something without compensation is Hiba.19

12 Mustafa and et al. (2011), vol. 1, p. 119 13 Ahmad (2009) 14 The Mejelle (2001), article: 834-835, p. 131 15 Al-Nawawi (1985), vol. 5, p. 364 16 Billah (2007), p.254 17 The Mejelle (2001), article: 833, p. 131 18 Ibn Abidin (2000), vol. 5, p. 687



Al-Mahalli (Shafi) also mentions the same definition is his illustrious work Sharh al-Mahalli ‘ala Minhaj al-Talibeen.20

3.1.3 THE VIEW OF MALIKIS Malikis’ definition of Hiba is:

Giving something in the personal ownership of the eligible receiver (whom the Tabarru is) through the legal transfer without compensation by explicit expression or whatever indicates it.21

It is interesting to note that the word Tabarru is explicitly mentioned in the original Arabic text of this definition; indicating that Hiba and Tabarru are, indeed, synonymous. All the above three schools, though use different wordings, have similar concept of Tabarru.22

3.1.4 THE VIEW OF HANBALIS It is a charity (Tabarru) from a living person of whatever is customarily considered as Hiba, valid only with the word of Hiba.23

The Hanbalis definition is more precise as compared to other schools of thought. Zuhaili provides a more detailed Hanbalis’ definition as:

It is a contract initiated by an eligible party to transfer ownership of existent and deliverable properties to another without compensation. The properties may be known or unknown, but they must be conventionally given as gifts, and the contract language must specify that it is a gift or a property transfer, etc.24

3.2 Axiomatic Features of Donation (Tabarru) in Islamic Law If all the above definitions are carefully examined then some manifested

characteristics of Tabarru (Hiba) may be derived as:

• The transfer of property in Hiba implies that a loan cannot be given as a gift; because a loan in Islamic law is not a property but a right.

• The gifted property must have some value; so, non-valuable goods cannot be given as gift.

• The gift of undeliverable commodities cannot take place.

• Both parties of Tabarru contract, the donor and the receiver, must be alive. This condition is stipulated to exclude the inheritance from this contract.

19 Al-Nawawi (1985), vol. 5, p. 364 20 Al-Mahalli (2001), vol. 3, p. 112-113 21 Al-Dardir (2000), p. 126 22 Zuhaili (2001), vol. 1, p. 539 23 Ibn Muflih (1997), vol. 4, p. 483 24 Zuhaili (2001), vol. 1, p. 539


• Tabarru is a voluntary unilateral contract and must be distinguished from commutative contracts; hence, there should be no compensation or consideration in return of the donation.

• Tabarru requires the immediate transfer of the ownership from the donor to the receiver. Hence, once given away, the donor ceases to have any right of ownership over the donation.25

• Once given away, the donor cannot take back the donation from the receiver. This prohibition is expressed by all non-Hanafi jurists based on various Ahadith (Traditions of the Prophet, أحاديث).26 On the contrary, Hanafis consider the Hiba contract as non-binding, and maintain that the donor may rescind the contract, and take the gift back. Hanafis’ view is also based on a Hadith where the donor is declared more worthy of his/her gift. However, Hanafis also hold that rescinding the gift is Makruh (an act of lowliness, 27.(مكروه

All these characteristics of Hiba (Tabarru) lead us to the question that if Hiba cannot be a compensatory contract then what is the standing of a compensatory gift in Islamic law? In next section, we try to find the answer of this question.

3.3 The Legal Status of Conditional Tabarru (Hiba) A compensatory gift (conditional Tabarru) is also known as al-Hiba Bi Shart al-

‘Iwadh (الهبة بشرط العوض) and al-Hiba Bi al-Thawab (الهبة بالثواب). It may be defined as:

It is a voluntary act that results in compensated ownership transfer between living individuals. Or it is a contract of donation with a condition of compensation.28

Zufar (a famous student of Abu Hanifa), along with Shafis and Hanbalis, deems this contract as a simple sale agreement, which can be validated if all the conditions of a sale contract are met. Other than Zufar, Hanafis consider the conditional Tabarru as a hybrid deal of gift and sale. They tend to opine that the conditional Tabarru is initially a gift pact, but after delivery of the gift, it will become a sale contract. Since conditional Tabarru, ultimately, becomes a sale contract, they are in agreement with Zufar that all the requirements of a sale contract should be fulfilled.29

Zuhaili cites that Malikis, in most of the cases, equate conditional Tabarru with sale contract; but in some exceptional cases, they treat it as a gift contract.30 However, the preferred opinion of Malikis is similar to what the other jurists hold. Hence, it can be concluded that all four schools of jurisprudence declare conditional Tabarru (gift) as a

25 Billah (2007), p. 254 26 Billah (2007), p. 256; Zuhaili (2001), vol. 1, p. 561 27 Zuhaili (2001), vol. 1, p. 559 28 Ahmad (2009) 29 Zuhaili (2001), vol. 1, p. 564 30 Zuhaili (2001), vol. 1, p. 564



contract of sale; and thus, all the legal conditions and requirements of sale must be satisfied for this contract to be validated.31

4. Application of Tabarru in Takaful Practices In 1985, International Islamic Fiqh Academy Jeddah resolved that the conventional

insurance practices are not in line with Shariah due to the significant uncertainty (Gharar, inhabited in the insurance system. The Academy further suggested that the Shariah (الغررcompliant way of insurance is through the principles of donation and mutual cooperation. Islamic law of contract emphasizes that major uncertainty should be avoided in all types of exchange contracts, because Gharar leads to contention; hence, any exchange contract should not contain Gharar. On the contrary, in unilateral contracts, it is tolerated, because these are benevolent contracts, which are voluntary in nature. Therefore, uncertainty is in-affective in such contracts. Due to this reason, Takaful system was founded and evolved on the concept of Tabarru and cooperation.32

Since, a Takaful operator is merely a manager of the fund on which it receives Wakalah fees, or share of the profit as Mudharib, or both, as per the stipulation of the contractual arrangement among Takaful operator and the shareholders. Takaful operator cannot be declared as the receiver of the donations, because the Takaful fund is separate from the Takaful operator; and thus, it cannot own the contributions. On the other hand, participants are the donors; they must cease their ownership of the contributions in order to make a valid donation. In addition, the joint pool of contributions (the Takaful fund) is not an entity, either real or legal, which could own the contributions as well.33 Therefore, there is a question that who is the real owner of the pool of contributions.

In order to overcome these issues and many other related problems, different approaches have been adopted. Some scholars proposed Waqf Model, as applied in Pakistan; some suggested Ta’awuni Model, and some advocated Wadi’ah Model.34 However, as this paper focuses mainly on the Model applied in Malaysia, the Malaysian model is closely examined here in the light of Shariah.

4.1 Tabarru Fund in Takaful as Applied in Malaysia: The participants of Takaful scheme (policyholders) pay an agreed amount

periodically, based on the type of policy they want to avail, in order to acquire the Takaful scheme. The contributions of the participants go into a joint pool which is operated and managed by the Takaful Company on the basis of Mudaraba, Wakalah, Ju’alah, or a hybrid of various Islamic contracts.35 Takaful is offered mainly in two types: family Takaful (an alternative to life insurance) and general Takaful (general insurance).

In family Takaful, the collected contributions are split into two segregated funds, namely: Participants’ Risk Fund (PRF) and Participants’ investment Fund (PIF). PRF is, basically, the portion of contributions which goes to the donation (Tabarru fund), which 31 Ismatullah (2009), p. 81 32 Arbouna (2008), p. 217-218 33 Ismatullah (2009), p. 78-79 34 Frenz and Soualhi (2010), p. 144-147 35 Frenz and Soualhi (2010), p. 127-128


is not individually owned by the participants. While, the PIF is the participants personal investment account. This portion exclusively belongs to the participant, and is invested by the operator on behalf of the participants. When a claim is filed, the benefit includes the sum covered which comes from PRF, the amount accumulated in PIF, and some proportional share from the Takaful surplus, if there is any.

Alternatively, in general Takaful, the whole contribution goes to PRF or Tabarru account. There is no personal investment account in general Takaful. If there is any claim, then the indemnification is paid out from the PRF only.

5. Deviations in Takaful Practices from the Theoretical Concept of Tabarru In the following discussion, we will try to point out some deficiencies in the

implementation of notion of Tabarru in Malaysian Takaful industry.

5.1 Issue of Ceasing Ownership It has already been established, in the previous discussion, that the transfer of

ownership in Tabarru is a conditio sine qua non for its validation. If a proper legal transfer of ownership does not take place, then the Tabarru cannot be confirmed. Furthermore, neither Takaful operator nor shareholders of a Takaful company enjoy the ownership rights over the Tabarru/Takaful fund. Then who is the initial receiver of Tabarru and who owns Tabarru fund? What is the status of the Takaful/Tabarru fund? Some weak responses have been noted in this regard; however, none of them are seemed to be satisfactory.

One response is that the Tabarru, in the context of contemporary Takaful system, is not a bona fide charity; rather it is more suitably a commitment to donate. In this case, the contract of Takaful obliges a participant to pay contribution in future.36 It means that the participants do not lose the ownership of the contributions right away; rather the transfer of ownership takes place later. The donation is taken out from the pool of contributions from time to time, whenever needed. If this is the case, then it implies that the concept of Tabarru is given a secondary position, and primarily, it is a contract of exchange. The participants do not lose their ownership over the Tabarru fund, and they hire Takaful operator for investing their capital into some profitable ventures. They simply make an agency contract with the operator, based on Mudaraba, Wakalah, etc.; and the Tabarru is only realized when a claim is registered. Secondly, this response gives rise to another problem, which is: in Islamic law, is it permissible to apply the rulings of a real Tabarru on a contract of mere commitment of donation in future? Or putting it differently, can the Islamic rulings of a contact of Tabarru be also applicable to a promise of Tabarru? Can a future promise be treated as a valid binding contract in Islamic law? It should not be forgotten that uncertainty (Gharar) is tolerated in such transactions in case of a real Tabarru contract only, which is unilateral in nature; but in this case, it is not a genuine Tabarru contract, it is just a promise of Tabarru. One may say that in this case, a promise of Tabarru is a binding pledge; hence, it may serve as a real contract of Tabarru. We opine that, although, some contemporary scholars support the binding nature of a unilateral promise in financial transactions; however, even according to them, a sheer

36 Frenz and Soualhi (2010), p. 135



promise cannot replace a real contract. Hence, a promise cannot be equivalent to a contract.37 Thus, this explanation seems to be unsatisfactory.

Another attempt to solve this problem was made by advising that each participant gives Hiba to other parties in the scheme without any consideration of compensation; and so, all the participants collectively own the fund, and have individual rights over it. Considering the case of family Takaful first, we observe that a large chunk of the contributions goes to the PIF for the investment purpose, which is neither Hiba nor owned collectively; rather, a very small part of the contributions is transferred to the donation fund. So, this justification is hard to apply in family Takaful.38 Secondly, when an individual participant gives Hiba/Tabarru, he/she also owns the joint pool of the contribution based on the contribution made, and obtains the same Tabarru in specified circumstances stipulated in the contact of Takaful. Although, this exercise transforms an individual ownership into a collective one, but the presence of the same individual in the group of owners of that fund precludes the absolute transfer of ownership of contribution from that individual to other participants. This argument may also be appreciated by the fact that the surplus earned on the Tabarru fund is exclusively owned by the participants and is distributed among them proportionately, which is due to the fact that they have the ownership rights over the capital in the first place.39 This fact points out that even after servicing the claims made over the donation fund, this fund belongs to the participants.

Moreover, it may be stated that in family Takaful, if the contributions are regarded as Tabarru, then only the beneficiaries can be entitled of the donation on the basis of need; but, the participants themselves cannot receive that donation. If they receive that donation, while at the same time they are the donors themselves, then it cannot be considered as Tabarru; because there will be no genuine transfer of ownership at all. From the general Takaful perspective, a similar situation may arise. The beneficiary is evidently the same participant, who gives Tabarru to the charity fund. In case if no peril occurs and no claim is made over the charity fund, then the operator provides no-claim bonus (NCB) to the participant upon the maturity of the policy. This also proves that the premiums are originally just contributions, neither donation, nor gift, or charity; because, the whole set up clashes with the very nature of Tabarru, Sadaqah, or Hiba.40

On the basis of the complications emerged due to the deviation from the original concept of Tabarru, many issues can be brought forward. In order to provide a glimpse of those issues, we may confine ourselves to pointing out only two of them.

5.1.1 THE ISSUE OF PAYMENT OF ZAKAH One of the indispensable stipulations which establish the criterion of levying Zakah

(Islamic charity, الزآوة) is the complete or established degree of ownership. Another condition is the possession of the Zakatable asset, either in real or constructive manner.41 This paper has already argued that the participants of Takaful scheme hold the Tabarru 37 Laldin (2009) 38 Bakar (2009) 39 Bakar (2009); Frenz and Soualhi (2010), p. 136 40 Billah (2007), p. 255 41 Diwany (2010), p. 214


fund in actuality, and the contributions do not depart from their ownership until they are paid in claims made against the fund. On this basis, one may conclude that the Tabarru fund is Zakatable, and the participants are obliged to pay annual Zakah based on the amount of their contributions. However, the task of calculating Zakah on the fund is not only an exceptionally exasperating job, but also the payment of Zakah on Takaful contributions does not occur at all in practice.42

5.1.2 APPLICATION OF ISLAMIC LAW OF INHERITANCE Usually, this situation arises in family Takaful. In family Takaful, the contribution

paid by the participant goes into two different accounts, namely: Participants’ Risk Fund (PRF) and Participants’ Investment Fund (PIF). Participants’ Investment Fund (PIF) remains exclusively in the ownership of the participant and forms the estate of that participant; hence, when that participant dies, the money in his/her PIF Account must be dispensed among his/her heirs according to the Islamic law of inheritance. However, to some scholars, it is still doubtful that whether the money payable by the Takaful operator from the PRF Account for the death benefit should be distributed among heirs or should be solely collected by the nominee.43

On the basis of the previous assertion that either in case of PRF or PIF, the ownership of the participant is maintained; it is exceedingly vivid that the death benefit of the Takaful scheme, either from PIF or PRF, should be treated as the estate of the deceased participant.44 Additionally, according to the standard practices in Malaysia, all the benefits of family Takaful are also allocated among the legal heirs of the deceased participant, and the nominated claimant is not considered as the sole beneficiary of the scheme.45 Therefore, as there is no transfer of ownership, the purpose of nominating a beneficiary is defeated.

5.2 Issue of Conditional Gift: Some scholars found it extremely intricate to rein the Takaful model under vanilla

Tabarru concept, so they urged to ameliorate the Takaful scheme under the concept of conditional gift (Hiba Bi Shart al-‘Iwadh or Hiba Bi al-Thawab). This suggests that the participants offer gift to the pool with a condition of compensation, whenever the specified risk transpires.46

In the preceding discussion, it has already been mentioned that all non-Maliki jurists unanimously agree upon the decree that the conditional gift in essence is a sale contract, and hence, all the requirements of the contract of sale must be satisfied in order to validate such contract. The preferred view among Malikis also corresponds to the opinion of majority of the jurists. Except in few cases, where they treat the agreement of conditional gift differently from sale.

42 Ismatullah (2009), p. 86 43 Noor and Abdullah (2008) 44 Ismatullah (2009), p. 86 45 Noor and Abdullah (2008) 46 Ismatullah (2009), p. 80



The conventional insurance is characterized as an exchange contract between the insured and the insurer.47 Since the structure is based on an exchange contract, it has been criticized by the Islamic scholars for containing three major defects, namely: interest (Riba, الربا), uncertainty (Gharar, الغرر) and Gambling (Maisir, الميسر).48 Our argument is that if Takaful model is structured on conditional gift, it will become an exchange contract. It will no longer remain a Tabarru agreement. Consequently, the three shortcomings of conventional insurance will also creep in to Takaful system.

5.2.1 PRESENCE OF RIBA In conventional insurance, the variance between the premiums paid and the sum

covered (benefit) is regarded by the Islamic scholars as Riba al-Fadhl (رباالفضل). The timing of these premiums and benefits is also not same, which gives rise to the issue of Riba al-Nasiah (رباالنسيئة).49 If the conditional-gift-based Takaful benefits are paid in cash, then the only way to avoid both types of Riba is that these benefits should be equal to the contributions paid and should be on spot; otherwise, it will also be tantamount to Riba al-Fadhl and/or Riba al-Nasiah.50 If these two provisions of equality and spot-basis are met to avoid Riba, the core rationale of Takaful will be vanished.

5.2.2 PRESENCE OF GHARAR In conventional insurance, the object of the contract is usually uncertain. The

policyholder and the insurer both either do not know the exact timing of an insured event at the initiation of the policy, or the amount to be paid by both the parties is not recognized, or the amount to be paid by at least one side is unknown. Therefore, this position creates Gharar, which is not tolerated by Islamic law in commutative deals. Additionally, the element of Gharar also leads to another harmful factor, which is ignorance (Jahalah, الجهالة).51

In summary, Takaful model based on conditional-gift, being an exchange contract, cannot avoid such kind of Gharar. It consists of the same Gharar as comprised by its conventional counterpart. Additionally, from Islamic law perspective, conditional-gift is only valid when the compensation is known to the donor, but in Takaful, it is unusually vague to the parties.52

5.2.3 EXISTENCE OF MAISIR Maisir (الميسر) is another word for Qimar (القمار); both the terms may be translated as

gambling. In insurance, the property/life of the policyholder is exposed to an uncertain event/death, which is out of his/her control. The policyholder pays some money in anticipation of a large sum of money, in case if that uncertain event occurs. This situation is very similar to Maisir; consequently, the insurance too is prone to Qimar/gambling.53

47 Arbouna (2008), p. 222 48 World Takaful Report (2011); Arbouna (2008), p. 222 49 Zuhaili (2001), vol. 1, p. 92-93 50 Ismatullah (2009), p. 83 51 Zuhaili (2001), vol. 1, p. 93-94 52 Ismatullah (2009), p. 83 53 Zuhaili (2001), vol. 1, p. 95


Takaful structure, standing on the notion of conditional-gift, may not be immune

from the same fault as the conventional insurance; because the participant under this system also expects a hefty compensation in return of his/her gift, at the time of contingency.

5.3 Bilateral Undertaking of Donation: Another solution was suggested as to lay down the basis of Takaful model on the

foundation of bilateral undertaking of Tabarru (Iltizam al-Tabarru, إلتزام التبَرع). In this situation, the participants undertake to donate the contributions to the joint pool. Interestingly, although it is a bilateral undertaking of Tabarru, but the proponents of this concept insist on considering it as a unilateral arrangement from both sides. They further assert that this undertaking will have a binding effect. This idea is borrowed from Ibn Dinar, Ibn Nafi, and al-Hattab from Maliki School of jurisprudence. Although, the preferred opinion among Malikis is identical to the non-Malikis view which states that the unilateral undertaking is legally non-binding and cannot be enforced by the court; however, these eminent scholars contrasted from the majority’s judgment, and construed authenticity of the enforceability of the unilateral undertaking.54

The weakness of this proposition is quite apparent. First, a bilateral undertaking is considered as unilateral in order to assume the arrangement, instead of exchange contract, as benevolent charity contract. Secondly, the so called unilateral contract is then declared as a binding one. Besides, in this system, a group of participants undertakes to compensate the contributors who file any claim, which is happened to be the same group of participants. In other words, the same group of participants is both the insured and the insurer. It should be noted that it is not the Takaful operator who undertakes to indemnify the participants, as misunderstood by some.55 In order to avoid this problem, it is argued that it is neither the participants nor the operator who assume the obligation of reimbursement in the event of stipulated incident; rather, it is the joint pool which accepts the burden of re-compensation of the participants.56 Nevertheless, in any of the case, one can readily observe that the undertaking of donation from the participant has to be met with the undertaking of compensation. Thus, it goes without saying that the responsibility of donation, promised by the participants, is not a unilateral undertaking; it is more accurately a bilateral undertaking of Tabarru. Hence, it will become a similar situation as of conditional-gift (Hiba al-Thawab). Therefore, all the issues related to conditional-gift stated previously will also creep in to this proposition. Furthermore, since the undertaking from both sides possess the characteristic of binding-ness and is enforceable by the court, this will also cause the problem of coercion in donation (Jabar fi al-Tabarru, جبرفي 57.(التبَرع

All in all the result of the above deviations has led to an increased absence of risk sharing—the essence of an Islamic finance. This is so because for risk sharing to take place, the understanding of the Qur’anic concept of al-bai’, as property rights exchange, has immediate implications for the observance of transparent and well protected property 54 Arbouna (2008), p. 225-226 55 Arbouna (2008), p. 226 56 Ismatullah (2009), p. 84 57 Ismatullah (2009), p. 85



rights, followed by clear contractual terms and conditions that facilitate such exchange. It appears that the current practice of Takaful based on the concept of Tabarru not only violates the above, but the apparent presence of Riba, Gharar and Maisir further hamper any risk sharing to take place. The result is a Takaful practice which is more in Shari’ah violation than compliance.

6. Conclusion and Recommendations Given the above Shari’ah appraisal, it appears that the present configuration of

Takaful industry (as is the case with present state of Islamic finance as a whole) may have shown some success, but it appears to have fallen well short of expectations in observing the fundamental tenants of an Islamic economic system. Perhaps the main reason can be linked to the fact that the practitioners and financial engineers of this new asset class – growing within the conventional financial system – have to design instruments that resemble those prevalent in the host system while at least being Shari’ah compatible in form, for example. This means creating instruments with tenuous relationship to the real sector which will try to avoid the risk of Islamic financial transactions borne by market players. Aside from these problems, there is a risk of path dependency: the risk that the industry will continue following the same pattern of behaviour because it has proven profitable thus far. This growing complacency and doing ‘business as usual’, runs the risk that path dependency will render deviations from the true practice of Islamic finance irreversible. This would mean a continuation of Takaful practices that in effect are devoid of risk-sharing elements – a vitally important element of Islamic finance. It has been shown that this brand of thinking has, in turn, led further to some serious deviations from essential Shari’ah rulings. This has forced many to term it as a ‘structure-objective mismatch’ (see for example Hasan, 2011 and Mirakhor and Shaukat, 2013).

One may deduce that the backbone of Takaful model is Tabarru. If the concept of Tabarru, which is a founding idea of Takaful structure, is correctly applied then the whole structure can stand straight. For the validation of Tabarru from Shari’ah viewpoint, the ownership of the participants over the Takaful fund should be completely ceased, and the donations should be made without any condition of compensation. This step will make the donations valid from Shari’ah standpoint. When the contributions of the participants become genuine donations, the non-commutative nature of the payments inoculate the Takaful model from the proscribed uncertainty (Gharar), interest (Riba), and gambling (Maisir).

The Takaful fund may be declared as a trust fund having a legal entity.58 If the Takaful fund becomes a legal entity, it will facilitate the fund in holding a property in its name and in making others the owner of a property which it holds.59 This Takaful fund will indemnify its donors (the participants) in case of any incident according to its own stipulated rules, rather than compensating the participants on the basis of their donations. The compensation offered by the Takaful fund, in this case, is a separate independent donation which is not based on the participants’ donation.60 However, since the coverage 58 Bakar (2009) 59 Usmani (2002), p. 225 60 Ismatullah (2009), p. 87-88


is offered according to the conditions of the trust (Takaful) fund, while the conditions stipulate that only those participants will be compensated who will pay the donations to the fund; a similar situation may arise as with the previous scenarios. It will be quite difficult to differentiate this setup with the previous structures.61 This issue can be dealt by including a certain percentage of non-donors in the Takaful scheme. Such Takaful scheme will maintain its clarity, transparency and compliancy by underwriting or by distributing some charity on permanent basis among a viable number of people who do not pay the donations to the trust fund. The number of non-donating participants may be set according to the affordability of the Takaful fund. Another way to provide such policy or charity is to prioritize the donating participants and serving the non-donating people with the surplus in the Takaful fund. Such amendments will not only counter the contention of “bilateral undertaking of donation”, but also eliminate the argument of conditional gift.

It can hence be asserted that the perception of Tabarru is the basic element in the composition of Takaful model, which is defined by Shari’ah as a unilateral contract in which the transfer of ownership of a property takes place without any consideration. However, in current Takaful practices, this notion is not so clear. Because the idea of Tabarru had not been applied in its original form, the need of other dubious and baffling explanations and theories was inevitable, but it only made the situation worse by making the whole structure questionable. If we could apply the Shari’ah instruments in their true essence, only then we could acquire a Takaful model which would be Shari’ah based, trustworthy, and at the same time profitable and resilient.

As mentioned earlier, the above can only be achieved if it is fully realized that in Islamic economics and finance, theories and practices cannot afford to be indifferent from the framework of Shari’ah acquiescence. The case of Takaful industry, as part of the same Islamic system, is of no different. The industry has to be compliant with the stipulated Shari’ah rules and principles, while remaining competitive in the insurance market. Essential among those are the rules that complete the whole gamut of an Islamic economic system; providing for a prosperous socio-economic order. Such orientation has to lead to better risk sharing in the society which in turn promotes unity—the main objective of Islam. Such expectations must be justified, if the scholars and practitioners want to deliver the world, a full-fledged Takaful system which may be deemed as a perfect substitute of conventional insurance.

References 1. Rodney Wilson, Legal, Regulatory and Governance Issues in Islamic Finance

(Edinburgh: Edinburgh University Press, 2012), 33.

2. Abbas Mirakhor, “Whither Islamic Finance? Risk Sharing in an Age of Crises”. Paper presented at the Inaugural Securities Commission Malaysia (SC)

3. Roundtable. “Developing a Scientific Methodology on Shari’ah Governance for Positioning Islamic Finance Globally”, (OCIS) – Oxford Centre for Islamic Studies, 2010).

61 Wahid (2009), p. 82



4. ———, “Islamic Finance in the Multi polar World”. (Presented at the Asian Institute Finance Distinguished Speaker Series. Kuala Lumpur, 13 September 2011).

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6. ———, “Risk Sharing and Public Policy”. (Paper presented in the 5th International Islamic capital Market Forum. Security Commission of Malaysia. Kuala Lumpur, 10th November 2011).

7. Abbas Mirakhor and Mughees Shaukat, “Regime Uncertainty: Interest rate based debt financing system”. The Journal of Islamic Business Vol.2, Issue 2 (December, 2012).

8. Abbas Mirakhor, Noureddine Krichene and Mughees Shaukat, “Unsustainability of the Interest Rate-Based Debt Financing”. ISRA International Journal of Islamic Finance Vol.4 Issue 2, (2012).

9. Abbas Mirakhor and Mughees Shaukat, “Islamic Finance iIn A Multipolar World: Traversing The Complexities of A New World”, The Journal of Islamic Banking and Finance. Vol 31, June 2013, Karachi, Pakistan (2013).

10. Mughees Shaukat, “Risk Sharing: An Alternative to Interest-Based Debt Financing”. ISRA International Journal of Islamic Finance. Vol.5 Issue 1. June 2013.

11. ____, “The Mejelle”, (Kuala Lumpur: The Other Press, 2001).

12. Adawiah, Engku Rabiah, & Hassan Scott P. Odierno, Essential Guide to Takaful (Islamic Insurance), (Kuala Lumpur: CERT Publications 2008).

13. Ahmad, Muhammad Ali Jinnah, “Hibah Bil Thawab: An Integral Part of Tabarru’ Philosophy”, (Kuala Lumpur: ISRA Bulletin, vol. 2, April 2009), pp. 8-9,.

14. Al-Mahalli, Jalal al-Din, Kanz al-Raghibin Sharh Minhaj al-Talibin lil-Nawawi, (Bayrut: Dar al-Kutub al-'Ilmiyah, 2001).

15. Arbouna, Mohammed Burhan, “Regulation of Takaful Business: A Shari’ah Overview of Contractual Aspects of Takaful Models”, (In Essential Readings in Islamic Finance, ed. Bakar, Mohd Daud, and Engku Rabiah Adawiah, Kuala Lumpur: CERT Publications, 2008).

16. Bhatty, Ajmal, “the Growth and Global Market for Takaful”, In Islamic Insurance: Trends, Opportunities, and the Future of Takaful, ed. Jaffer, Sohail, (London: Euromoney Institutional Investor Plc, 2007).

17. Billah, Mohd Ma’sum, Applied Takaful and Modern Insurance: Law and Practices, (3rd Edition, Selangor: Sweet & Maxwell Asia, 2007).

18. Diwany, Tarek El, Islamic Banking and Finance: What It Is and What It Could Be, (1st Edition, UK: 1st Ethical Charitable Trust, 2010).


19. Frenz, Tobias, and Younes Soualhi, Takaful & Retakaful: Advanced Principles &

Practices, (2nd Edition, Kuala Lumpur: IBFIM, 2010).

20. Ibn Abidin, Radd al-Muhtar ‘ala al-Durr al-Mukhtar, (Beirut: Dar al-Fikr. 2000).

21. IFSB and IAIS, 2006, “Issues in Regulation and Supervision of Takaful (Islamic Insurance)”, Issues Paper, (August-2006).

22. Ismatullah, Takaful Ki Shara’i Hesiyat, (Karachi: Idaratul Ma’arif, 2009).

23. Laldin, Mohamad Akram, “The Concept of Promise and Bilateral Promise in Financial Contracts: A Fiqhi Perspective”, (ISRA, Research Paper No. 4/2009, Kuala Lumpur: International Shari'ah Research Academy for Islamic Finance, 2009).

24. Mustafa, Ibrahim, Ahmad Al-Zayyat, Hamid Abdul-Qadir, Muhammad Al-Najjar, “Al-Mu’jam Al-Waseet”, Maktabah Mishkat Al-Islamiyyah, retrieved from: http://www.almeshkat.net/books/archive/books/almuajm%20alwaset.zip (accessed march 16 , 2011).

25. Noor, Azman B. Mohd, and Asmadi B. Abdullah, “Ownership and Hibah Issues of the Takaful Benefit”, (ISRA Islamic Finance Seminar (IIFS), 11th November, 2008).

26. Usmani, Taqi, The Principle of Limited Liability, (In Meezan Bank’s Guide to Islamic Banking, author: Muhammad Imran Ashraf Usmani, Karachi: Darul Ishaat, 2002).

27. Wahid, Abdul, Hadiyah-e-Jawab, (Karachi: Majlis Nashriyat Islam, 2009).

28. World Takaful Report, “Transforming Operating Performance”, (4th annual Edition, Ernst & Young, 2011).

29. Yusof, Mohammed Fadzli, “the Concept and Operational System of Takaful Business”, (London: New Horizon, No. 5, May-1996, p. 10-13 and June-1996 p. 12-14).

30. Zuhaili, Wahbah, Financial Transactions in Islamic Jurisprudence, (Damascus: Dar al-Fikr, 2001)

31. World Takaful Report, “Transforming Operating Performance”, 4th annual Edition, Ernst & Young, (2012).

32. Ibn Muflih, Abu Abdullah Muhammad, Al-Furoo wa Tashih al-Furoo, (Bayrut: Dar al-Kutub al-‘Ilmiyah, 1997).



Comparison of Efficiency in Conventional and Islamic Banks Using Data Envelopment

Analysis (DEA) By

Muhamad Nadratuzzaman Hosen* Zahra Rosa Amalia

Syafaat Muhari

Abstract One of the financial performance measurements of banks is to look at level of efficiency and this has been a concern of Financial Service Authority (FSA) of Indonesia. The level of efficiency is not only important for conventional banks but also important for Islamic banks to enable expansion by increasing the number of bank offices or new products. This research is based on data from four conventional banks i.e. Bank Mandiri, BRI, BCA and BNI and four Islamic banks i.e. Bank Syariah Mandiri, Muamalat, BRI Syariah and Mega Syariah during the period of 2009-2012. Method used in this research is the Data Envelopment Analysis (DEA) with intermediation approach and Constant Return to Scale (CRS) and Variable Return to Scale (VRS) models. The results showed that there is no significant differencies between conventional banks and Islamic banks’s level of efficiencies using CRS and VRS models. On the other hand, the result of paired sample t-test showed that there is a different level of efficiency between CRS and VRS model. This research showed that fixed asset variable (technology) and labour cost are significant influences in the differences between CRS and VRS models.

Keywords: Data Envelopment Analysis (DEA), Conventional Banks, Islamic Banks, Constant Return to Scale (CRS), Variable Return to Scale (VRS)

* Authors: Muhamad Nadratuzzaman Hosen, Zahra Rosa Amalia,Syafaat Muhari are

associated with UIN Syarif Hidayatullah Jakarta, Indonesia, E-mail: [email protected], [email protected], [email protected]


1. Introduction

The important thing for a bank is how wellable it is to maintain the quality of performance and bank’s soundness. One of the measurements of financial performance of banks is by looking at level of efficiency. Bank’s efficiency is one of the important thing that has been a concern of Financial Service Authority (FSA) of Indonesia. Operating Expenses Ratio (OER) often used to measure the bank’s efficiency. The OER of Islamic Banks in December 2015 is 97.01%, which mean that Islamic Banks used Rp. 97 in cost, to get Rp. 100 revenue. The ratio is higher than conventional banks where OER score is 81.49% in the same period. Meanwhile, Islamic Banks has reduced the OER compared to previous year which score is 96.97%.

Although Islamic Banks OER ratio is now lower, the level is still higher than conventional one and other countries. OER ratio of commercial banks in Indonesia is 81.49% at end of December 2015, while the average of OER ratio in ASEAN is only about 40%-60% (Kontan:27 December 2012). Therefore, it is very important for a banks to know the sources of their inefficiencies in order to get the ideal OER that is recommended by FSA (Financial Service Authority). If the bank can achieve a certain level of OER, it should expand by opening new branch offices or selling new products.

Measurement of bank efficiency is generally only seen from OER ratio. Banks have many avenues of expenses and income and it is difficult to pinpoint the exact cause of inefficiency . Actually efficiency measurement would be simple if a bank only has one input and one output for their production, but banks generally need multiple inputs to generate various outputs. Technical efficiency measurement using multiple input and output are expected to give a new way to measure bank performance and can explain the real bank performance. Expected discovery of causes of inefficiency can be used to bring corrective policies to improve the quality of bank performance.

Looking from the development level of OER Conventional and Islamic Banks in the figure 1, conventional banks are able to reduce the level of OER compared with Islamic banks.

Figure 1 OER Level of Conventional Banks and Islamic Banks In 2015 (%)

Source: Financial Service Authority (2015), Data Processed

Comparison of Efficiency in Conventional and Islamic Banks


Efficiency is very important in Islamic banks as it relates to the primary function to efficiently utilize resources for productive financial activity or output. So the use of resources and optimum output can be achieved by all Islamic banks. If not, the problem of inefficiency or lack of efficiency will arise in Islamic banks Overall, the performance of the Islamic banks will increase the efficiency of the banking and finance industries, and increase economic growth (Zainal and Ismail: 2012).

This study was also based on the research gap on the efficiency of banks conducted by Mohammed Shamsher et.al. (2008). They investigated the comparative efficiency of conventional and Islamic banks in 21 countries that are members of the OIC with the SFA method. This study says that there is no significant difference between the efficiency of Islamic and conventional banks. However, it is in contrast to the results of the research study conducted by Ali Said (2012). Ali Said examines the changes in the efficiency of conventional and Islamic banks. The results of his study showed that Islamic banks have not decreased in efficiency when the global financial crisis occured in 2008.

Another study comparing efficiency of conventional to Islamic banks was also performed by Ascarya, Yumanita and Rokhimah (2008) which examines the comparison of conventional commercial banks and Islamic commercial banks in Indonesia during the period 2002-2006. The results of this study indicate that conventional banks performed better on efficiency, but Islamic banking is more efficient in the scale, technical and overall efficiency. By looking at the condition, the problem identification in this study are (a) What is the level of efficiency of conventional and Islamic banks during the period 2009-2012, (b) Is there a difference in the level of efficiency of conventional and Islamic banks during the period 2009-2012, (c) Is there a difference in the level of efficiency of conventional and Islamic banks using CRS and VRS assumptions during the period 2009-2012, (d) What variables caused inefficiency both in Conventional and Islamic Banks.

II. THEORITICAL BACKGROUND A. Efficiency Theory

Definition of efficiency can be seen from many different points of view. Efficiency can be defined as the ratio of input to output (Kost and Rosenwig, 1979:41). There are three factors that lead to efficiency, i.e. when the same input produces greater output, when the smaller input produce the same output, and when a large input produces greater output (Sutawijaya & Lestari: 2009). The concept of efficiency is rooted in the concept of micro-economics, the theory of consumption and production theory. Consumption theory tries to maximize utility or satisfaction from the point of view of the individual, whereas the theory of production to try to maximize profits or minimize costs from the point of view of the manufacturer (Ascarya and Yumanita: 2008).

In production theory, there is a production frontier line that describes the relationship between inputs and outputs of the production process. The production frontier line shows the maximum output of the usefulness of each input. The line also indicates the use of technology by Islamic banking windows or industry. Islamic banking windows that operates on a production line efficiency frontier techniques.


Figure 2: Production Frontier Line

Source: Coelli, et. al. (2005)

B. Data Envelopment Analysis (DEA) DEA method developed by Farrell (1957) to measure the productive efficiency

based on production possibilities consists of a variety of input-output lines. Measurement efficiency with single input/ output by Farrell generalized to multiple input/output and formulated as mathematical programming by Charnes, Cooper and Rhodes (1978). Charnes, Cooper and Rhodes called it the method of Data Envelopment Analysis. This technique was originally used to measure and compare the relative efficiency of a Decision Making Unit (DMU) (Zamorano: 2004).

Model developed by Charnes, Cooper and Rhodes (1978) is known as the CCR model. Here's a picture of the CCR model and its explanation. A, B, C, D, E and G are the six Decision Making Unit (DMU) which produce output Y with two inputs: X1 and X2. DG line describing the unit is obtained with DEA techniques from five population data Decision Making Units (DMU), each using two different amounts of inputs to produce a single output in a variety of sizes. Inefficiency level of each unit is determined by comparing the DMUs with others by isoquant frontier line and the use of inputs in the same proportion.

Figure 3” CCR Graphic Model

Source : Zamorano (2004)

Therefore, the technical efficiency of A can be represented by the ratio OA*/OA where A* is a combination of B and C lines that use inputs in the same proportion with A. Efficiency E can be measured directly by comparing it to C, which is where the line isoquant efficient E equal to C. The ratio OC/OE determine technical efficiency of E. In



the end, despite being in line G unit efficiently, it cannot be considered as technical efficiency in the sense of Pareto, although G uses the same amount of input X2 to B, but using more inputs X1 to produce the same amount of output.

DEA method to calculate the efficiency frontier 'find' part DC, CB and BG that affect the performance of all UKE. Isoquant frontier line is not exact but it is estimated that the line where the peak of the D, C, B and G depict actual DMU when the unit is between F and A* is a unit which is calculated as a weighted average of the input. Technical efficiency score of each unit was then calculated (not estimated) by using mathematical programming technique in which the solution will be required to satisfy the inequality on the dividing line in order to increase or decrease the output or input without reducing other inputs or outputs.

Therefore, to determine the efficiency score of each unit, it will be compared with the 'peer group' which is in line efficient DMU combination. N is the DMU known as categorized by the input and output lines with m inputs and s outputs, each unit not placed on efficient lines can be written in equation μ− = (μ……,μN) where μj represents each of DMU each belonging to 'peer group'. DEA calculations are designed to maximize the efficiency scores and are relatively few of DMU. Subjects had to adjust the weights of other DMU of DEA efficiencies that exist in the sample. Efficiency score can be calculated with mathematical programming as follows:

TECRS = minμ ψ0 s.t. n

Σ μjXij ≤ ψ i = 1, …, m j=1 n

Σ μjYrj ≥ r = 1, … s ………… (1) j=1

The solution of the linear program mentions that the peer group of each DMU has been analyzed, at least not to the same level of output but spent only a proportion (ψ) on each of the inputs used by the DMU. DEAs ultimate goal is to minimize the value of DMU ψ respectively. Technical efficiency score will be determined by optimization ψ*.

The two models are often used in operations research techniques. Of the two models can be generated maximum weight ratio of an input for a similar limited in order for each UKE.

st .………… (2)


Where wr and zi are the weights for the maximization and Yrj and Xij are the input

and output of each DMU. This formulation ensures that 0 < Max H0 < 1. Moreover, DMU will achieve efficiency if the ratio is as the same as a whole, otherwise it will be considered a relative inefficient. As Coelli, Rao and Battese pointed out (1998), one problem with this formulation is the ratio allowing for an infinite number solution: if wr and zi is the solution to the linear programming problem and then αwr αzi is also the solution. This can be avoided by specifying additional constraints:

∑ =

iii X 10

ι ……… (3)

0,

0

1s.t.

0

0r

>

≤−

=

∑∑

∑

∑

ir

iii

rrr

iii

rrir

jjXY

X

YMax

ιω

ιω

ι

ωιω

……….. (4)

The model is called CCR models that assuming Constant Returns to Scale (CRS). CRS assumes that the performance of all DMU is at the optimal scale. In fact, companies are rarely the optimal conditions for a variety of things such as market forces, financial constraints, external factors, imperfect competition and others. Banker, Charnes and Cooper (1984) developed a theory prior to adding other elements on the DMU called BCC models assuming Variable Return to Scale (VRS). VRS by adding the convexity constraint modeled Σμj = 1 which has been formulated on the model 1. The results simplified that each DMU can only be compared to the same size of another DMU. This equation avoids detrimental effects on the scale efficiency to technical efficiency score. Results of the linear programming problem can be written as follows:

∑

∑

∑

=

=

=

=

=≥

=≤

=

n

1

0n

1jj

n

1j

0j

0

1

s , . . . 1, r

m , . . . 1, i

s.t.min

jj

rrj

iij

VRS

YY

XX

TE

μ

μ

ψμ

ψμ

…………….. (5)

Connecting the origin point between A and B describes the line technology combined with the assumption of CRS. Based on this specification, only the A and B units will be considered as technical efficiency. Other units are not as efficient as A and D would have the efficiency score ratio described in Xh/Xa and Xj/Xd, second row is less than the overall value. By using VRS, score efficiently is computed efficiently from a line



defined by line Xa, A, B, C and stretched to the point C. Due to lack TECRS more limited than VRS formulation, the lowest efficiency scores are possible with VRS. In this case, A, B, and C point to efficiency. In contrast, unit D is still inefficient but has changed its efficiency score of the ratio Xj/Xd CRS into the Xw/Xd on VRS.

Figure 4. Constant, Variable and Non-Increasing Return to Scale

Source: Zamorano (2004)

In the end, two alternative specifications of the linear programming and the relationships formulation, measurement of scale efficiency can be calculated: In CRS and VRS unit B is technically efficient. Instead, units A and C assuming VRS is efficient but not efficient with CRS frontier efficiency, which means that the size of these units deviate from optimal scale. In conclusion, measurement of scale efficiency can be described by the ratio TECRS/TEVRS. Thus, unit D is not technically efficient in both efficiency frontiers. In this case, the total technical efficiency (TTE) can be decomposed into two components: pure technical efficiency (PTE) and scale efficiency (SE), based on the following relationship:

TTE = PTE x SE Where TTE= Xj/Xd, PTE = Xw/Xd dan SE = Xj/Xw

Although there is no general agreement on the approach used as well as in terms of determining the DEA input and output, but in this study the authors use the intermediation approach because look at the bank's main role is as an intermediary between the parties with the excess funds. In addition, to be able to perform its function as an intermediary institution, banks require human resources, fixed assets and deposits (third party fund) (Hidayat: 2011). Input variables in this study are labor costs, fixed assets and total deposits, while the output variable is total financing and fee based income.

III. RESEARCH DESIGN The population in this study is conventional banks and Islamic banks which are

registered with Central Bank Indonesia in 2009-2012. The samples in this study is purposive sampling, which means the sample was selected based on consideration of (judgement sampling) which means that the selection is not a random sample of the information obtained by certain considerations.


Table 1

Bank’s name and code Bank’s Group Bank’s name Bank’s code

Conventional Banks Mandiri 1 BRI 2 BCA 3 BNI 4

Islamic Banks Syariah Mandiri 5 Muamalat 6 BRI Syariah 7 Mega Syariah 8

Before measuring the difference in the level of efficiency of conventional and

Islamic banks, we first tested the data for normality Kolmogorov-Smirnov Test. For the normal distributed data we will use independent sample t-test and we will use Wilcoxon Signed Rank test if the distribution of data is not normal. While to measure differences in the level of efficiency of conventional banks and Islamic banks with CRS and VRS assumptions made Paired Sample t-test. Significance level is set of 5%.

IV. RESULT AND DISCUSSIONS A. Conventional and Islamic Banks Efficiency

Figure 5 The Efficiency level of Conventional and Islamic Banks Based on CRS and VRS Assumption in 2009 – 2012 (%)

Based on figure 5, it can be seen that there are differences in the level of

efficiency on average between conventional and Islamic banks in 2009-2012 using DEA method. The conventional and Islamic banks average efficiency with VRS models is higher than the CRS models one.

In general the level of the VRS efficiency is higher than the CRS model both in conventional and Islamic banks. On the assumption of CRS conventional banks, the variable component of the total financing is the most efficient where the level of efficiency reached up to 100%, while the assets remain the most inefficient variable with



the level efficiency set just at 53.7%. On the assumption of VRS Islamic banks, the variable component of the total financing is the most efficient where the level of efficiency reached up to 99.86%, while total deposits are the most inefficient with a variable rate of 76.52%.

Table 2 Average level of achievement Efficiency of Each Variable Input and Output of

Conventional Banks and Islamic Banks in Period 2009-2012 (%)

Conventional Banks Islamic Banks Variable CRS VRS CRS VRS

Cost of Labour 75.16 89.65 79.01 92.10 Fixed Assets 53.70 79.10 78.11 90.80 Input

Total Funding 81.88 92.75 76.52 92.23

Total Financing 100.00 99.04 99.86 93.70 Output Fee Based Income 70.55 91.08 92.60 86.71

C. Statistical Tests 1. Assumptions Kolmogorov-Smirnov for Normality Data

Tabel 3 Normality Test Data

CRS VRS Conventional

Banks Islamic banks Conventional Banks Islamic Banks

0.855 0.270 0.013 0.022

If Asymp. Sig. (2-tailed) > α (0.05) then H0 is accepted, which means the data is in the normal population. On the Kolmogorov-Smirnov normality, Asymp value. Sig. (2-tailed) Islamic banks and conventional banks assuming CRS> 0.05 which means Asymp. Sig. (2-tailed) > α (0.05) so that H0 is accepted. If the data are normally distributed, then different test is used to compare the level of efficiency of Islamic banks and conventional banks in CRS assumption is independent sample t-test. While the value Asymp. Sig. (2-tailed) Islamic banks and conventional banks assuming CRS <0.05 which means that the data were not normally distributed and used different test is the Wilcoxon Signed Rank Test.

2. Difference in test for Conventional and Islamic Banks efficiency using CRS and VRS assumptions models

Tabel 4 Independent Sample t-test

Variable N Mean SD Sig. - Conventional Banks - Islamic Banks

64 64

81.87 79.47

12.64 15.11 0.332


Tabel 5

Wilcoxon Signed Rank Test Variable Sig. (2-tailed) -Conventional Banks -Islamic Banks

.250

According to the table of independent sample t-test for the CRS efficiency of Conventional banks and Islamic banks shows that the average level of efficiency of conventional banks and Islamic banks using CRS assumption in DEA method is respectively 81.87% and 79.47% with a standard deviation of respectively 12.64% and 15.11%. From the results of statistical tests it can be concluded that there is no significant difference between the level of efficiency is based on the assumption conventional and Islamic banks and CRS (the sig. = 0.332) because of sig. > α (0:05). While from statistical test results it can be concluded that there is no significant difference between the level of efficiency is based on the assumption conventional banks and Islamic banks VRS (sig. = 0.096) because of sig. > α (0.05).

3. Paired Sample t-test for comparison of CRS and VRS assumptions Tabel 6

Paired Sample t-test Variable Df Sig. (2-tailed) Conventional Banks - CRS - VRS

63 0.000

Islamic Banks - CRS - VRS

63 0.000

From the results of the statistical test paired sample t-test comparing the efficiency of conventional banks is based on the assumption of CRS and VRS can be concluded that there are significant differences between the levels of efficiency of conventional banks CRS and VRS (sig. = 0.000) because of sig. < α (0.05). Furthermore, the results of paired sample t-test comparing the efficiency Islamic banks based on CRS and VRS assumptions, it can be concluded that there are significant differences between the levels of efficiency of Islamic banks assuming CRS and VRS (sig. = 0.000) because of sig. < α (0.05).

Differences in the level of efficiency with CRS and VRS assumptions for both conventional and Islamic banks has very real significance level. This is due to the fact that VRS is a model that opens the possibility of influencing the level of efficiency of production scale, one of which is the technology used (Priyonggo Suseno : 2008 in Maflachatun : 2010).

Table 7 Human Resources and Technology Influence to CRS and VRS Assumption

CRS VRS Variable Bank’s Code Bank’s Code

1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Cost of Labour √ √ √ √ √ √ √ Fixed Assets √ √ √ √

Source : Data Processed



By using regression analysis it can be seen that the cost of labor and technology (which is reflected in the fixed assets) have a significant influence on the efficiency of banks in particular on the assumption of VRS. At CRS assumption is only 3 banks which have significant effect to CRS assumption and no banks which have significant effect to CRS Assumption. Then fixed asset tested their effects on the efficiency of the VRS assumption, 4 banks has significant fixed assets affect to the VRS assumption. Labor cost to the efficiency of VRS assumption also have a significant effect in 4 banks.

V. CONCLUSION 1. The Average efficiency levels of conventional banks during the period 2009 - 2012

amounted to 81.87% by CRS assumption and 91% by VRS assumption. While the value of the average efficiency of Islamic banks using CRS assumption is 79.47% and 87.57% by VRS assumption. Its means conventional banks are more efficient than the Islamic banks both on CRS and VRS assumptions.

2. From the results of independent sample t-test, it can be concluded that there are no significant difference between the level of efficiency of Conventional and Islamic Banks based on CRS model (p value = 0.332) for p > α (0.05). Efficiency of conventional and Islamic banks efficiency based on VRS assumptions respectively 91.18% and 87.57% with a standard deviation respectively 9.96% and 14.03%. From the results of statistical tests it can be concluded that there are no significant difference the level efficiency of Conventional and Islamic banks based on CRS model (p value = 0.096) for p > α (0.05). So we can conclude there are no significant difference between the efficiency of conventional and Islamic banks by using CRS and VRS assumptions model.

3. From the results of the statistical test paired sample t-test, it can be concluded that there are significant differences between the levels of efficiency conventional banks by CRS and VRS assumptions (p value = 0.000) for p <α (0.05). Furthermore, the results of paired sample t-test, it can be concluded that there are significant differences between the levels of efficiency Islamic banks assuming CRS and VRS (p value = 0.000) for p <α (0.05). So it can be concluded that the conventional and Islamic banks has a different value of the efficiency by using CRS and VRS assumptions model.

4. Efficiency level of total funding and total financing variable by Islamic banks is lower than conventional one both CRS and VRS assumption. It indicates that the intermediation function of Islamic banks to financing is relatively low than conventional one.

VI. References Ascarya, Diana Y. and Guruh S. R. (2008). Analisis Efisiensi Perbankan Konvensional

dan Perbankan Syariah di Indonesia dengan Data Envelopment Analysis (DEA)” Paper in “Buku Current Issues Lembaga Keuangan Syariah Tahun 2009”. Tim IAEI. Jakarta : Kencana Prenada Media Group

Ascarya and Diana Yumanita. (2008). Comparing the Efficiency of Islamic Banks in Malaysian and Indonesia. Buletin Ekonomi Moneter dan Perbankan, Vol.11, 2. p.95-115.


Chansarn, Supachet. 2008. “The Relative Efficiency of Commercial Banks in Thailand”,

International Research Journal of Finance and Economics, Issue 18, p.53-68.

Coelli, Tim., et. al. 2005. An Introduction to Efficiency and Productivity Analysis. New York. Springer.

Efendić, Velid. 2012. “Efficiency of the Banking Sektor of Bosnia-Herzegovina with Special Reference to Relative Efficiency of the Existing Islamic Bank.”8thInternational Conference on Islamic Economics and Finance. p.1-13.

Mohamad, Shamsher, Taufiq Hassan, and Mohammed Khaled I. Bader. (2008). Efficiency of Conventional versus Islamic Banks: International Evidence using the Stochastic Frontier Approach (SFA). Journal of Islamic Economics, Banking and Finance. Volume 4, 2. p.107-130.

Shahid, Haseeb, et. al. 2010. “Efficiencies Comparison of Islamic and Conventional Banks of Pakistan” International Research Journal of Finance and Economics. Issue 49. p. 25-30.

Said, Ali. (2012). Comparing the Change in Efficiency of the Western and Islamic Banking Systems. Journal of Money, Investment and Banking, Issue 23, p.149-180.

Sutawijaya, Adrian and Etty Puji Lestari. (2009). Efisiensi Teknik Perbankan Indonesia Pascakrisis Ekonomi: Sebuah Studi Empiris Penerapan Model DEA. Jurnal Ekonomi Pembangunan, Vol.10, No.1. p.49-67.

Zainal, Noor Saliza and Mahadzir Ismail. (12-13 March 2012). Islamic Banking Efficiency: A DEA Approach. 3rd International Conference On Business and Economic Research (3rd ICBER) Proceeding.

Zamorano, Luis R. Murillo. (2004) Economic Efficiency And Frontier Techniques. Journal Of Economic Surveys. Vol.18, No.1 p.33-76.



Islamic Social Finance: A Sustainable Means of Alleviating Poverty

By Akeem Kolawole Odeduntan & Tajudeen Adetokunbo Oni*

Abstract The emphasis of Islamic finance has been continually laid on public interest which is believed to have had long lasting positive impact not only on socio-economic wellbeing but also on day-to-day affairs. The present paper seeks to bring to light institutions Islam puts in place to strengthen our social interaction thereby preventing socio-economic unrest, poverty, violence, terrorism and insurgency. The paper adopts a qualitative research approach to examining theoretically Islamic social finance in the perspective of communal oriented institutions such as Zakat and Waqf. Being a library-based research, the paper specifically applies the content analysis method to unravel the social values and goals of Islamic finance. The exploratory study on the subject matter was carried out by reviewing and analysing relevant literature. The outcome of this paper revealed that Islamic social finance remains one of the viable options of restoring peace and tranquility to the world system.

Key words: Social Finance, Maqasid Sharia’a, Gift, Public Interest, socio-economic wellbeing

1. Introduction The goals of Islamic finance can be perceived right from the terms it rests upon,

that is finance and Islam. While the term, finance, suggests that Islamic finance addresses economic issues such as resource allocation and management as well as acquisitions and investments the term Islamic, implies there are certain unique factors imbedded in it that create divergence from the existing or subsisting whether in its principle, operation or outlook. These factors are evidently drawn from the provisions of the Shariah.

* Authors: Akeem Kolawole Odeduntan & Tajudeen Adetokunbo Oni are Chartered

Accountants, affiliated with Ahmed Zakari & Co. (Chartered Accountants), Lagos, Nigeria. E-mail: [email protected]/ [email protected]


Meanwhile, the main goal of Islamic finance is often captured in one general term

of Maqasid al-Shariah. This terminology may be described simply as the objectives of Shariah. It facilitates improvement and perfection of the conditions of well-being of on social justice and will in all ramifications have positive impacts on the total welfare of the masses. Its non-negotiable and vehement prohibitions on financial transactions that are based on interest, gambling, speculation, fraud, bribery, corruption, and the likes align with Maqasid al-Shariah.

On a macro level, the reason for provision for the so-called Shariah advisors, whose primary responsibilities within Islamic financial institutions are to verify and endorse products as Shariah compliant for market dissemination by deducing laws from the reliable sources of Shariah to be able to develop an egalitarian society. This obviously is another mechanism introduced into Islamic finance for the purpose of achieving an overall spiritual development and material well-being of the general populace.

However, an economic system that is not founded on social justice will impact a great deal on the individuals in such society. The monumental implications of making the prohibition of Riba or Usury (Interest) as the norms and a way of life on the global economy cannot be overemphasised. For instance, the 2007/2008 global financial meltdown can be traced down to subprime mortgage in the US which is a question of Riba (interest), the collapse of most firms of international standard including Lehman brothers also in the US was a case of fraud and corruption. Their effects are also as numerous as their causes. For example, the increasing gap between the wealthy and the poor, increasing rate of poverty, violence and insurgences all over the world, insecurity and a host of others.

The crux of the matter is that as humans we do not own anything; we are only privileged to have whatever we have in our possession. For instance, we do not own the air we breathe in, we do not own the sun neither do we own the earth and its vast resources. We do not even own our body let alone our soul. All of these endowments are given to us as gift and so the onus lies on us to give back to the society what we have benefitted from it. Thus, whoever has more than enough he should give the rest or part of it to those who do not; this way we might live together as brothers. Rather than strive towards enriching ourselves alone, substantial efforts should be dedicated towards wealth circulation so as to promote social wellbeing and peaceful co-existence among humanity.

2. The Need for Social Finance Hitherto, the traditional financial system has not been able to resolve some of the

socio-economic problems ravaging the world economy. High rate of poverty, injustice, deprivation, ecological destruction and many others are manifestations of the multifaceted crisis enveloping the world. Consequently, the emergence of Islamic economics and finance especially its phenomenal growth and success at least in the last three decades is considered not only as an alternative to the conventional system but also as a remedy to the world’s economic and financial crises. Hence, Islamic finance is expected to provide fundamental and substantive change to some of these lingering problems.

The widespread social unrest and poverty as currently experienced in the world especially in the developing and less developed countries is worrisome. It is in a sorry



state or a condition where people cannot meet their basic needs vis-a-vis food, clothing and shelter let alone other important needs such as health care and sanitation, safe water supply and a host of others. Be that as it may, Islamic finance, being a divinely motivated system, is therefore set out to promote the general wellbeing (Maslaha) of people which happens to be one of the manifestations of the Maqasid al Shariah (the real essence of Shariah). Thus, the potentials of Islamic economics and finance in curbing social disorder and alleviating poverty cannot be overemphasized.

In the recent times, several continuous efforts aimed at eradicating poverty have emerged. One of such is the World Bank’s target of eliminating poverty around the world by 2030. However, despite all these painstaking efforts, a substantial part of the world still wallow in abject poverty, a situation that portends that the state of affairs of many people is still unsatisfactory. Consequently, it behoves economists, financial experts and other professionals to go back to the drawing board and scrutinize all opportunities available especially those offered in Islamic finance with a view to finding lifelong solution to this menace called poverty.

At this juncture, it must be emphasized that Islam values prosperity and happiness. It therefore urges its adherents to aspire for bounties in this world while seeking the pleasure of their lord, Allah. However, Islamic economic and finance explains that while trying to achieve affluence, attention must be paid to poverty alleviation through its various institutions as shall be discussed later. In other words, Islamic finance introduces certain institutions charged with the aims of income redistribution and wealth circulation among others within members of a given society. These are Islamic microfinance institutions and charitable resources in the form of the institutions of Zakat and Sadaqah. Besides, other potent palliative measures that can be employed to eliminate poverty and bring about a just society are Waqf and Qard ul Hasan.

Meanwhile, we must realize that poverty does not exist in isolation. It has been found to have direct impacts on many aspects of our socio-economic life. This includes education, health, labour market, agriculture, livestock and food security and many others. This, thus, justifies the need to fight it instantaneously. Many instruments in Islamic finance as mentioned above can contribute in no small measure to eradicating poverty and enhancing welfare in the society. Giving the principles of fairness, justice and equity that characterise Islamic finance, it is unambiguous that adopting its model of poverty alleviation ensures that every individual in a society is confident of a minimum income which in the long run contributes to social security system within such society.

3. Islamic Microfinance System The fact that about three billion people all over the world still live on less than $2

per day is nerve-racking and so calls for immediate action. It may not be out of place if subsequent editions of world economic summit or any other similar world economic gathering is conveyed to address issues that border around poverty in their deliberations. In the course of our study, we have identified earlier some of the mechanisms adopted to unfold the Islamic social finance. For the sake of reinstatement, we need to emphasize that Islamic microfinance structure is a major institution that showcases social finance in Islam.

Microfinance, as the name indicates, can be referred to as a financial service of small quantity provided by financial institutions established for that purpose for the benefits of low income earners. It is a short term lending and provision of money to the


poor or the disadvantaged for the purpose of wealth creation. By short term, we mean such lending or financing is to be repaid within a short period of time. Over the years, microfinance has been used to empower low income earners, individuals or households economically and financially. It has been a source of succour for small or medium scale entrepreneurs who have no financial wherewithal to obtain loan from commercial banks. It has been a very effective tool to reduce poverty in countries where they are effectively run and managed. Apart from reducing the rate of poverty, microfinance has contributed in making education accessible to all and sundry. It has not only led to increase in income or earning of its customers but has also enhanced better medical facilities for the people and of course promoted women empowerment in one form or the other.

However, the conventional microfinance suffers some setbacks as it is based on interest which is the root of most socio-economic problems. Owing to the features of interest, some elements of injustice and inequity still dominate the institution. Certain ethical questions are still not resolved. Besides, high transaction cost and lack of mutual trust and confidence between the bankers and their supposed customers are some of the problems facing the operations of microfinance world-wide. Anyway, one may not actually expect significant difference in the operational modalities of conventional microfinance and conventional commercial banks. The only difference perhaps might be that of their target customers. While commercial banks are patronized by middle or large scale entrepreneurs as well as corporate firms for financing, microfinance institutions are basically for small scale and in few cases medium scale enterprises. Hence, the need for a viable alternative becomes germane and this is what non-interest based microfinance tends to resolve. The interest free system as exemplified in Shariah (i.e Islamic finance) assists in reducing the vulnerability of the needy or the poor or the less privileged members of the society through economic empowerment by creating new employment opportunities to reduce poverty.

The Islamic alternative mode otherwise referred to as Islamic microfinance has evolved lately to cater for the yearnings of the less privileged who even though might be poor would still like to keep their religious tenets by not patronizing interest based system. Some other members may choose not to run after the conventional system for reasons such as high transaction cost, lack of mutual trust and confidence, unfairness, high interest rate and others identified above.

The Islamic microfinance model is exclusively based on divine principles and rejects in its entirety any elements of Riba (Interest), Gharar (Uncertainty/Speculation) and Maysir (Gambling) in all forms of transactions including financial. Considering the increasing rate of poverty within the less developed and developing nations, the most rational way to help the less privileged members of the Society is to provide sustainable economic opportunities at grass-root level, involving availability of required financial services at competitive rates to support their investments and business activities, which of course is the ulterior motive of Islamic microfinance.

Consequently, Islamic microfinance offers products that are not only favourable to the vulnerable population, that is, the poor or entrepreneurs of SMEs but are also accessible to meet their day-to-day financial obligations. Therefore small or even middle scale entrepreneurs may walk up to Islamic microfinance institution with the details of his business ideas or proposals for any necessary financing. In the long run, both parties



will be satisfied as their individual economic goals will be fulfilled. However, Islamic microfinance products are not different from those ones adopted in the main stream of Islamic finance and so they have certain features which include risk sharing, profit sharing, fixed repayment rates, transparency, social welfare and justice. A brief explanation of each of these is thus given below:

3.1 Risk-sharing: The Islamic microfinance institutions share potential risks between their investors and clients. This explains why Islamic microfinance becomes more attractive for borrowers who will not carry the full risk which is against many conventional products.

3.2 Profit-sharing: In Islamic microfinance, both the institution and the customers enter into a partnership agreement. Thus, the lending institution is not a sole financier but a co-owner of the business with a strong interest in its success. The profit from such investment or business activity is shared based on the pre-determined ratio.

3.3 Fixed repayment rate: Based on the principle of Islamic finance, Islamic microfinance products have a fixed repayment rate with no possibility of making profit through Riba (interest).

3.4 Transparency: Islamic finance does not tolerate any form of ambiguity. Both parties must clearly understand the terms of agreement and so the customer cannot be exploited owing to his financial impediment. Besides, the principle stipulates that contracts with a fixed liability should be known to the customer upfront.

3.5 Social welfare and justice: Since the ultimate goal of Islamic finance in general and Islamic microfinance in particular is to ensure growth with equity for social welfare and justice, Shariah-compliant financing places emphasis on substance over form. The economic substance of any dealing is preferred over the legal or procedural structure.

Finally, being a socially-based type of financing, Islamic microfinance products have huge potentials to alleviate poverty and if this is employed the world will witness monumental growth and development. Insecurity and justice will become things of the past.

4. Zakat and Sadaqah The institutions of Zakat and Sadaqat are among several instruments instituted in

Islam to combat poverty and promote the wellbeing of people. These institutions also encourage wealth circulation and redistribution of income. Zakat is one of the cardinal principles of Islam and so it is obligatory on adult wealthy Muslims whether male or female whose wealth satisfies certain stipulated conditions to observe. These conditions include the fact that the source of the wealth must be lawful (Halal); the payer must be a Muslim, adult, sane and must not be indebted in anyway, the amount must reach the minimum allowable rate (Nisab) within the course of a year.

Sadaqah, on the other hand, is a way of going the extra mile, it is the supererogatory form of Zakat and it is also enjoined on every privileged Muslim who may not necessarily be rich but is comfortable. It does not have the conditions attached to Zakat other than the fact the source of wealth must be lawful. Thus, the rich who pay


their Zakat do additional rewarding acts through paying Sadaqah while others who are not qualified to pay Zakah (simply because their wealth do not meet the minimum amount) are encouraged to pay Sadaqah; it is actually a platform for all and sundry to participate. Zakat and Sadaqah have many objectives - spiritual, economical and social. The Quran explicitly describes the spiritual objective in Q9 vs 103 as a means of purifying one’s wealth:

“Take out of their wealth Zakah that so thou mightiest purify and sanctify them”

A brief analysis of the above verse shows that the primary essence of Zakah is to purify and cleanse the payers. In other words, just as the essence of fasting in Islam is to attain God consciousness the very essence of Zakat/Sadaqat is soul purification and rejuvenation. To further justify the spiritual implications of Zakat, one of the foremost scholar of Islamic literature, Ibn Taimiyah, opined that the inner soul of the Zakat payer becomes better while his wealth becomes cleansed. Besides, Zakat and Sadaqah have been found to be helpful in purifying the human soul from the vices of stinginess, greed, covetousness, lustfulness as well as other inner germs of spiritual diseases.

Meanwhile, there are many socio-economic benefits of paying Zakat and Sadaqat. It reduces concentration of wealth in the hands of the few thereby enhancing circulation of wealth. It also helps the less-privileged in the society including the poor, orphans, widows who are unable to fulfil their needs, not because they are handicapped or lack administrative acumen or are bereft of ideas but because they do not have the capital or the resources to transform their ideas into realities. The institution of Zakah also provides a platform to help people - the less-privileged members of the society either by virtue of insufficiency of wealth or inability to work. Therefore, these sets of individual should not be unduly subjected to abject poverty but could be assisted swiftly through the proceeds of Zakah and Sadaqah thereby reducing poverty rate to the barest minimum.

Furthermore, the Qur’an identifies the recipients of the proceeds of Zakat and by extension of Sadaqat. These are people who for one reason or the other are under either temporary or permanent circumstances that are beyond their control and thus do not have the wherewithal to help out and comfort themselves; hence, the need to assist them. The list of categories of people that are entitled to the proceeds of Zakah as enumerated in Q9:60 are: The poor; the needy; Zakat collectors; winning over hearts (i.e people whose faith are weak and new reverts); slave seeking ransom; the indebted, in the cause of Allah (i.e the participants in the cause of establishing Islam as well as the erecting facilities/structures such as Mosque, school, hospital, Muslim cemetery, orphanage homes, etc.); and wayfarers.

The categories of people the Almighty Allah enumerated in the Quran as recipients of Zakah and by extension Sadaqah cut across people of different classes of needs. They represent conditions or circumstances human beings can find themselves by virtue of divine decree or individual laxity or incapability or insufficiency or whatever. The bottom-line is that at that material time they are in need and will like to meet their basic needs. Their state of affairs makes the susceptible to violence as the popular saying goes - “a hungry man is an angry man”. Since the Maqasid Shariah (essence of Shariah) is peaceful co-existence of people irrespective of their races, religious, ethnical, and socio-economic backgrounds, Zakat and Sadaqah therefore play an important role in realizing



this objective. Given the fact that everyone cannot equally be blessed and everyone cannot be a leader, the onus lies on the privileged ones to assist the less privileged; this is the nature of life. Therefore, to bring about desired peace in any society the principle of equity as instituted in Zakat and Sadaqah must be ingrained.

Unfortunately, the rate of social insecurity and poverty in the world is becoming alarming, not because there is no more soil to till or the water from the sky has stopped endlessly. But the problem is that the wealthy nations or should I say that the developed countries have continued to impoverish the poor ones, the developing and less developed through conditional financial aids in form of loan imbued with compound interest. The economic interest of these big nations supersedes whatever interests other nations of lesser socio-political status may harbour. This is as far as international relation is concerned. Worse still is the state of affairs on the local scene; the wealthy ones rather than play their role in eliminating poverty - rather than breach the gap between the rich and the poor, continually take advantage of the less privileged. Thus, today we put profit above people; greed above need; rule of gold above golden rule and the consequences of our nonchalant attitude, greed and selfish interest include prevalence of violence; insecurity and insurgency, militancy, hatred, despondency, distrust and of course poverty.

The institutions of Zakat and Sadaqah provide a palliative measure to the problems of social vices and poverty that are ravaging the world. For Zakat, only 0.025 (or 2.5%) of one’s wealth is to be remitted annually as Zakat while for Sadaqah it is as much as you can afford. In a sophisticated environment such as ours scholars agree that the Zakat might be remitted to a Zakat based institution or organization that collects and disburses Zakat and Sadaqat appropriately. In some other societies, especially Muslim states, Zakat and Sadaqah are placed under a ministry or arm of the government who does not only oversee the payment of Zakat and Sadaqah but also oversees the distribution taking into cognizance the eight categories of people mentioned in the Quran. The Zakat and Sadaqah proceeds can be used to facilitate or finance the less privileged that are business-driven or artisans but lack financial wherewithal to establish themselves in their respective careers.

Besides, the proceeds of Zakat and Sadaqah can be used for community based activities such as paying tuition fees, hospital bills and so on for the poor and their children. The proceeds of Zakat and Sadaqah can also be channelled towards reducing illegal sexual intimacy among young adults who are ripe for marriage. These unmarried men and ladies who are likely to constitute nuisance to the society can be helped by empowering them so that they can get married as soon as possible. We can use the proceeds of Zakat and Sadaqah to assist the debtors by offsetting their debts thereby making them free of the pang of debt. Furthermore, we can empower the unemployed youths by organizing skill acquisition programs for them from the proceeds of Zakat and Sadaqah. This makes them to be self sufficient and even be employers of labour in their own realms. This might not only cut down the number of people that run after white collar job but also reduce unemployment in the long run and so the society becomes a better place for us all to live.

5. Waqf Unlike Zakat and Sadaqah institutions that most people are familiar with, Waqf

(pl. Awqaf) is another palliative measure Islam introduces as a social finance technique to


combat poverty and promote peaceful and healthy relationship among members of a community. By a way of definition, waqf can be described from literary perspective as to hold, confine, detain, or restrain. In technical or usage form, the term Waqf means protecting something, by preventing it from becoming the property of a third person. It could be described as withholding the ownership of a designated asset while releasing its usufruct. Besides, Waqf is seen as a practice of withholding an asset and getting it out of anybody’s property so that it cannot ve sold, granted and bequueathed. In some parts of the world particularly North and West Africa, Waqf is also regarded as Habs (pl. Ahbas or Hubus). Besides, it represents property or assets dedicated in perpetuity for specific beneficiary for the purpose of achieving specific objectives.According to most scholars, waqf is often seen as Sadaqatu Jariya (continuous charity).

A waqf may be cash money, real property, land, building, agricultural machineries, livestock, shares or any movable property which can be made use of even if it is a common property. In other words, Waqf does not apply to perishable commodities because their benefits and usufruct cannot be extracted; they are rather consumables. Therefore, perishable items such as food, farm produce and the likes cannot be made Waqf. A person may dedicate his property as Waqf property for a specific objective while at the same time more than one person or a group of people can join hands together to form a waqf through cash or in-kind shares; whatever be the case, the objective of such must be clear. Meanwhile, the waqf property is expected to be effectively managed so that it does not get reduced and adequate accountability and transparency must be ensured. The Islamic law that governs the Waqf property allows the provider of such asset (Waqif) or his designate to manage it.

Waqf has significantly contributed immensely through Islamic history on the religious, social, cultural, scientific, economic and political life of the Islamic society to such a great extent that its endowment has benefitted every conceivable enterprise of social benefit including among others building mosques, universities, schools, hospitals, orphanages, homes for the poor; provision of food for the poor, the blind, the widows; constructing wells, aqueduct, fountains, public baths, watchtowers, bridges, cemeteries, libraries and so on. Thus, during the golden age of Islam, some people benefitted immeasurably from Waqf institutions as they were products of waqf hospitals, waqf schools, waqf universities, waqf based social amenities and so on. Hence, it is an institution that aids social development to keep pace with economic growth in the society.

The institution of Waqf in no small measure assists the contemporary socio-economic set-up to uncover additional source supporting the existing programs and activities towards poverty alleviation. Judging from its history from the time of the prophet and his companions to the dynasties era up to our contemporary time, Waqf has the potentials to mobilize additional resources for poor members of the society to address various socio-economic issues in terms of education, skills and micro entrepreneurial development, health care and care of infected population of life threatening diseases such as cancer, HIV, etc, and water and sanitation facilities especially in rural areas. Waqf fund, if properly invested can be utilized to help people in extreme poverty facing starvation, death and diseases.

Most scholars often regard the waqf by Umar ibn al-Khattab (RA) as the most prominent example of a charitable waqf.



Ibn Umar reported that: Umar acquired a land at Khaibar. He came to Allah's Apostle (may peace be upon him) and sought his advice in regard to it. He said: Allah's Messenger, I have acquired land in Khaibar. I have never acquired property more valuable for me than this, so what do you command me to do with it? Thereupon he (Allah's Apostle) said: If you like, you may keep the corpus intact and give its produce as Sadaqa. So Umar gave it as Sadaqa declaring that property must not be sold or inherited or given away as gift. And Umar devoted it to the poor, to the nearest kin, and to the emancipation of slaves, aired in the way of Allah and guests. There is no sin for one, who administers it if he eats something from it in a reasonable manner, or if he feeds his friends and does not hoard up goods. (Sahih Muslim, Volume 13, Number 4006).

From the foregoing, it is evident that waqf is one good means that we can take advantage of to combat poverty that is ravaging the world. The proceeds from Waqf asset could be utilized to provide small scale business opportunities for the poor or empower artisans who have the prerequiste knowledge and skill but do not have the financial ability to start-off or take care of the basic needs of the less privileged or the physically challenged if they do not fall within the category of people who are able and are willing to work. The proceeds can also be deployed to provide infrastructural facilities that every member of the community especially the poor will benefit from. Thus, if we must take the bull by the horns in our struggle to fight poverty, we must begin to look in the direction of the opportuties available in Waqf. While the government is duty bound to provide an enabling environment, the individuals and groups of individuals, the wealthy and the philantropists should employ this by parting with their wealth for the overall welbeing of all and sundry. The Almighty Allah has stated in Q3vs 92 thus: “Never will you attain righteousness until you spend from that which you love ...”

6. Qard Hasan (Benevolent Loan) Apart from various means of poverty alleviation introduced by Islam, Qard Hasan

is yet another method that can be employed to curtail poverty to the barest miimum level and promote social wellbeing. Qard Hasan is a combination of two words. Qard is described as a loan given for something good or a loan given to help someone for the sole aim of earning the pleasure of Allah. It is lending of an exhaustible thing from one person to another which is repayable as its equivalent. On the other hand, Hassan means kindness or goodness. It is an act that benefits persons other than those from whom the act emanates without any obligation.

Qard Hassan is simply an interest-free loan; a beneficial loan or benevolent loan or gratuitous loan. It means lending with no interest and has no profit out of merit. Umer Chapra defined it as a loan which is returned at the end of the agreed period without any interest or share in the profit or loss of the business. Therefore, it is a kind of loan contract (or debt based transaction) that involves two parties on the basis of social welfare. The lender should be fully aware that he is making a loan to someone in need without expecting anything in return from him or any mortal but his intention is in order to please Allah. This contract fulfils the short term need of a borrower. At maturity which may be determined and agreed by both parties, the repayment must the exact amount


borrowed, that is, no interest or Riba is charged or applicable. However, based on the opinions of some scholars it is permissible for the borrower to pay additional amount if he so wishes; it must be at the prerogative of the borrower and must not be the condition for granting the loan and no percentage amount should be fixed upfront.

The value of Qard Hassan is mentioned in various portions of the Qur’an, one of such is that in Q57vs11 thus: “Whoever is it that would loan Allah a goodly loan (Qard Hasan) so He will multiply it for him and he will have a noble reward?”. Also in Q2 vs 245, Allah says: “

245. Who is he that will loan to Allah a beautiful loan, which Allah will double unto his credit and multiply many times? It is Allah that giveth (you) Want or plenty, and to Him shall be your return

.” Also, in another portion, specifically, Q64 vs 17, Allah declares: “If you give Allah a qard hasan, He will multiply it for you and forgive you. And Allah is Most Appreciative and Forbearing”. Equally, Q57 vs 18 says: “Indeed, the men who practise charity and the women who practise charity and (they who) have loaned Allah a goodly loan – it will be multiplied for them, and they will have a noble reward.”

Relaying his experience during Isra’ wal miraj, the prophet (SAW) remarked: "In the night of the journey, I saw on the gate of heaven written, 'reward for Sadaqah is ten times and reward for Qard (or an interest-free loan i.e. Qard-al-Hasana) is eighteen times'. So, I asked the angel, how is it possible? The angel replied, 'because the beggar who asked had already had something but a borrower did not ask for the loan unless he was in need.” – Sunan Ibn Majah.

Since Islam emphasizes brotherhood and cooperation among its adherents, the concept of Qard Hasan aims at satisfying the following objectives: to help the needy; to establish cordial relationship among the poor and the rich; to mobilize wealth among people in the society; to perform good deeds encouraged and appreciated by Allah (SWT) and Prophet Muhammad (SAW); to strengthen the national economy; to facilitate the poor to create new job market and business venture by using their merits, skills and expertise; to establish a caring society; to eradicate unemployment from the society and to remove social and economical discrimination in the society.

7. Conclusion The overall interest of the Islamic social finance is the provision of finance to the

poor so as to increase their income and wealth thereby making them to be less dependent on others for sustenance. This paper has identified various means of making fund available to the poor or the small scale entrepreneurs which includes micro financing, Zakat and Sadaqah, Waqaf and Qard Hassan so that wealth will continue to circulate and poverty which is the root of all social menace will be curtailed significantly. Therefore, the concept and application of Islamic social finance will genuinely cater for the needs of the poor and the less privileged and of course in the long run generate socio-economic growth of the community at large.



In the same vein, this paper has been able to contribute to the extant literature in the areas of social finance system that is available in Islamic finance. It has been able to unveil the social finance structures including their efficacy in bringing about social justice among the members of a given community. Since everything was given to us a gift as we do not own all of the things that keep us alive we should not hesitate to reciprocate by giving out especially things we have as excess to those who are in need of them so as to bring about peaceful co-existence. Consequently, for us to promote healthy relationship among people of different background and socio-economic status, concerted efforts should be made not only by government but also by the privileged individuals in the society to enhance adequate framework for social finance. By so doing, poverty that has been found to be the root of all social vices and social insecurity will become a thing of the past and the world will become a better place for us to live.

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Country Model

Tunisia* Islamic banking started in Tunisia with the arrival of Albaraka Bank in 1983.

At present, apart from Albaraka Bank, one more Islamic Bank (Zitouna Bank established in 2009) is operating in the country. Moreover, UAE’s Noor Bank is also present in the Republic through a representative office. The country is a member of the Islamic Development Bank (IDB) while Central Bank of Tunisia is an associate member of the Islamic Financial Services Board (IFSB). Apart from Islamic banking institutions, Islamic fund management companies and Takaful companies are also offering Islamic financial services in Tunisia. It is, however, pertinent to note that despite offering services in the country for more than three decades, Islamic finance still accounts for only 2.5 percent of Tunisia's financial sector.

Regulatory Framework for Islamic Banks in Tunisia Presently, there is no exclusive Islamic banking regulatory framework in

Tunisia and the industry is operating under the country’s civil law framework. A comprehensive Islamic finance regulatory framework covering Sukuk issuance, Banking, Takaful, Zakat and Waqf has been drafted in November 2012 though the government has not yet approved the draft framework. However, additional legislations relating to Islamic finance have been passed including Sukuk law, specific tax mechanisms for Sukuk &Shariah funds and insurance law providing legislative framework for Takaful. Further, the parliament has also issued a draft law of banks and financial institutions in 2015 which has defined few Islamic finance contracts.

Sukuk Tunisia has been contemplating issuing a sovereign Sukuk since 2014,

however, to date no sovereign Sukuk has been issued from the Republic. According to reports the proposed Sukuk is likely to be issued in 2016 and IDB has agreed to guarantee Tunisia’s sovereign Sukuk of up to US$600 million. It is however, encouraging to note that a corporate Sukuk has been issued in the country by Tunisian Islamic Bank Zitouna in December 2015 valued at 22.5 million euros.

Way Forward

* Source: State Bank of Pakistan, Quarterly Islamic Banking Bulletin Jan-Mar 2016


A number of conventional banks in Tunisia have shown inclination towards starting Islamic financial services. These include Amen Bank, the country’s second-largest conventional private sector bank, which has formally requested the Central Bank to create an Islamic bank as a subsidiary or, where appropriate, an Islamic window. Moreover, leasing firm El Wifack has signed an advisory services contract and term sheet with the Islamic Corporation for the Development of the Private Sector (ICD) to facilitate its conversion into a full-fledged Islamic bank. In addition to new entrants, existing Islamic banks in the country have also indicated aggressive expansion plans for 2016. Islamic capital market in the country is also likely to get a boost as issuance of ’ first sovereign Sukuk is likely in near future. With an increased focus of Islamic banking and finance in the country, complemented with a large Muslim population, Tunisia has potential to create an important place for itself in the African Islamic banking and finance industry in the coming years.

Sources

• www.islamicfinancenews.com

• Global Islamic Finance Report, Edbiz Consulting Limited, various editions.


Book Review1 The Great Escape: Health, Wealth, and the Origins of Inequality

Angus Deaton

Angus Deaton is the 2015 Nobel Laureate in economics. In his book ‘The Great Escape’, he tells an optimistic recent history of how we have overcome extreme poverty, improved life expectancy and achieved economic progress. Admittedly, life expectancy has increased substantially since the onset of 20th century. It is not just the rich who expect longer lifespan due to technological developments and their mass availability, but the poor countries have also witnessed notable improvements. Extreme poverty has also declined, especially in Asia due to economic growth in East Asia. According to the World Bank, the number of people living on less than $1.25 per day was 1.22 billion in 2010, compared with 1.94 billion in 1981. Optimistically, the Nobel Laureate exclaims that life is better now than at almost any time in history.

However, discussing these issues without historical and institutional context can lead to a lot of problems in understanding. Deaton also questions the widespread presumption that rising inequality is always a bad thing. In developing countries, he wrote, “inequality is often a consequence of progress.” To the question what should we do to alleviate poverty? Deaton challenges this question, asking “why is it we who must do something? Who put us in charge?” Instead, the developed countries should leave developing countries to develop on their own, in their own time, just as the West itself did. He writes “I have come to believe that most external aid is doing more harm than good”. He writes: “If it is undermining countries’ chance to grow—as I believe it is—there is no argument for continuing it on the grounds that ‘we must do something.’ The something that we should do is stop.”

Nonetheless, Deaton says that great escape “is far from complete.” Innovations reach only those who can afford to pay for them. And that has led to great inequality. In fact, inequality has sharply increased since the 1980s in West despite slower growth and despite no evidence of increase in productivity at least in empirical literature. Deaton correctly notes that the sharp rise in inequality cannot be ignored. If left unchecked, it will undermine economic growth as well as democracy.

One must balance the optimism with some ground realities. Bottom billion even in 21st century suffer from abject poverty and have low life expectancy. According to FAO, approximately, 800 million people still suffer from undernourishment and one in nine people go to bed hungry every day. Quarter of the whole population in Africa suffers from hunger. Also, nearly 50 percent of people living in extreme poverty are 18 years old or younger. This goes on to show that a significant portion of our global population would not have a fair start to achieve socio-economic mobility.

1 Book Reviewed by Salman Ahmed Shaikh is pursuing PhD Economics at National

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


On the question of should the more fortunate, enjoying longer and more affluent lives, give more money to help them? Deaton says ‘No’. The author explains that the main barrier to progress in poor countries is not lack of resources but bad governments. When these governments receive the aid either directly or indirectly, it brings complacency, dependency and undermines governments’ incentives to raise money from their own taxpayers. The author opines that aid mostly goes to the countries for political and strategic geo-political motives. Samoa, for instance received $802 per capita in 2010, while the highest amount of aid per capita ever in India was $3.10. When aid comes as ‘tied aid’, the recipient country is forced to use the aid funds to buy goods from the donor country even when this is a commercially expensive proposition.

However, the author undermines the fact that most of the poor countries lack basic resources to kick start growth and invest in health and education. The mere scientific solutions to health and education problems solve the supply side problem, but not the demand side problem since these essential services are produced and marketed in the global market economy on commercial basis. He also ignores the huge transfer of funds from highly indebted poor countries to their rich lenders, mostly in the West. He also treats the issue of ‘tied aid’ quite superficially. If aid comes with ties that impose restrictions on recipient country, then it would undermine its effects. Then, the problem is not so much with aid per se, but attaching inappropriate trade ties, starving the poor indebted countries on their debt servicing, asking for abrupt commercialization of basic necessities and imposing free trade reforms. Many proponents of aid, including Jeffrey Sachs, argue that people in developing countries are too poor to save and invest in capital which could improve their income prospects. Furthermore, if legitimately elected, but weakly funded democracies are not supported in their economic programs, then it could undermine people’s confidence in democracies.

Deaton considers alternative policies that might be more effective, including removing unhelpful trade restrictions, enabling temporary migration and providing incentives for drug companies to invest in cures for illnesses such as malaria. Nonetheless, with weak economic recovery in West, Brexit and contagion effects of War on Terror, economies may become more restrictive, cross border flow of human services face more frictions and the commercial corporations moved by instincts of greed may find no incentive and reason to come to the plight of poor people. Rapid commercialization of drinking water and other basic necessities is the case in point. More people have access to mobile phones than basic sanitation facilities in some regions. According to The Hunger Project, 2.4 billion people do not have adequate sanitation and each day, nearly 1,000 children die due to preventable water and sanitation-related diarrhoeal diseases. It is partly because sanitation is not good business than cellular services. Thus, if public welfare support programs are not supported, it can lead way to more gaps in basic services delivery. Thus, on the whole, while we may take courage from the snapshot view, it is not enough reason to take a blind eye towards significant challenges that we face today.


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.


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Journal of Islamic Banking and Finance Julyl – Sept 2016...

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