On Corporate Social Responsibility of Islamic Financial Institutions
On Corporate Social Responsibility of Islamic Financial Institutions
On Corporate Social Responsibility of Islamic Financial Institutions
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SAYD FAROOK∗
1. INTRODUCTION
It is evident that there is now, more than ever a debate raging within the
academic community (as witnessed in the 6th International Conference on Islamic
Economics and Finance, Jakarta, Indonesia) and in the practitioner community (as
witnessed in the World Islamic Banking Conference, Manama, Bahrain 2005) as to
whether IFIs have achieved or are even close to achieving the objective promised
30 years ago to implement a just and equitable distribution of wealth. Further, the
debate questions whether it is justified in allocating the role of a charity
organization to an Islamic Financial Institution (IFI). It has been argued that IFIs
are like any other conventional financial institution, which acts as an intermediary
between providers of funds and fund users, the only difference being that the
transactions and contracts of an IFI must comply with Islamic law.
On the other hand, others argue that implicit in the laws of Islamic finance (i.e.
the spirit of the laws) is an ethical guideline to ensure that some or all of the funds
∗
Center for Islamic Finance, Bahrain Institute of Banking and Finance (BIBF), e-mail:
sfarook@bibf.com.
32 Islamic Economic Studies, Vol. 15, No. 1
provided from investors are used to redistribute wealth within society profitably.
This can be done in a number of ways and have proved to be profitable areas of
investment for a number of Islamic and conventional banks alike (for e.g. through
micro-financing). Moreover, there are those traditional means by which to
redistribute wealth through methods such as zakat, qard, and waqf.
Indeed, the founding fathers of modern day Islamic finance have concurred to
the view that IFIs do have a heightened sense of social responsibility, as do any
other ‘Islamic’ institution. However, this does not entail IFIs to become
uncompetitive and unprofitable charitable organizations used to only further social
development objectives. This entails a change in the mindset of Islamic bankers to
incorporate social development objectives into their portfolio of investments
profitably.
However, this is not to say that IFIs should implement corporate social
responsibility because of its long term economic benefits. While viable economic
institutions have to be driven by profit incentives, in the case of IFIs, it is not their
only priority and certainly not the only reason for them to implement corporate
social responsibility.
Indeed, any notion that IFIs or any other institution that claims to be Islamic, for
that matter, should be socially responsible must derive its justification from Islamic
law and principles, as contained within the Qur’an and the Sunnah of the Prophet
of Islam, Muhammad (P.B.U.H). Without this ultimate source of legitimacy, there
is no reason for any action.
This study provides the foundation of social responsibilities that are applicable
to IFIs derived particularly from those divine sources. It is proposed that Islamic
banks should be socially responsible for two interconnected reasons: first, they
fulfill a collective religious obligation (fard kifayah) for Muslims and hence they
are in a position to fulfill an enlarged scope of responsibilities that Muslims cannot
fulfill individually; second, they are in an exemplary position in society. These
reasons provide the basis for the development of a structure for corporate social
responsibility standards based on a dichotomy of mandatory and recommended
conduct.
Sayd Farook: On CSR of Islamic Financial Institutions 33
ICSR derives itself from core principles in the holy Qur’an. The three major
foundational principles for ICSR are the vicegerency of mankind on earth, divine
accountability and the duty on mankind to enjoin good and forbid evil.
2.1. Vicegerency
The principle of divine accountability flows from the vicegerency principle and
denotes that individuals will be accountable to Allah for all of their actions on the
Day of Judgment. This principle is expounded in several verses of the holy Qur’an,
two of which are: ‘Allah takes careful account of everything’,3 and ‘Then shall
anyone who has done an atom’s weight of good shall see it and anyone who has
done an atom’s weight of evil, shall see it’.4 This divine accountability is the basis
for all actions of a Muslim 5 , and in turn the representative organizations of
Muslims.
1
Surat Al Baqarah (The Heifer) verse 30.
2
Surat Al Ana’m (Cattle) verse 165.
3
Surat Al Nisa (Women) verse 86.
4
Surat Al Zalzala (The Earthquake) verse 7-8)
5
One who submits to the will of Allah.
34 Islamic Economic Studies, Vol. 15, No. 1
says: ‘The Believers, men and women, are protectors one of another; they enjoin
what is just (accepted), and forbid what is unjust (rejected)…’ 6 and in another
verse, Allah states: ‘You are the best of peoples, evolved for mankind, enjoining
what is just (accepted), forbidding what is unjust (rejected), and believing in
Allah’. 7 This responsibility is overwhelming and encompasses all aspects of a
Muslim’s life. It comprises a prescription towards positive (permissible and
recommended) actions and a prescription against negative (impermissible and not
recommended) actions. IFIs have generally ensured their operational status by
avoiding negative actions. However, their approach to positive actions has been
varied due to a lack of standards in the area.
6
Surat Tawba (The Repentance), verse 71.
7
Surat Al-i-Imran (The Family of Imran) verse 110.
8
Fard Kifayah refers to a collective religious duty which, if performed by some, would
exempt others from performing it. However, if it is not performed by any, the entire
community is sinful.
9
The IFIs are representatives for individuals who:
i. invest their money as shareholders or investment account holders,
ii. have co-operative, partnership or borrowing relations with the IFI,
iii. are employed by the IFI,
iv. have other explicit contractual relations with the IFI,
v. in addition to the above, have an implicit social contract with the IFI as part of the
larger community (Ummah).
Sayd Farook: On CSR of Islamic Financial Institutions 35
In this special position, IFIs are able to perform the obligations and
recommended actions that Muslims cannot perform individually. They have the
ability to influence allocative justice through their transactions, something beyond
the reach of an individual Muslim, but recommended in the strictures of Islamic
principles.
It is for these two reasons that IFIs and any other representative ‘Islamic’
institution that is performing a fard kifayah, for that matter, have a special duty of
social responsibility. This social responsibility is an extension of the social
responsibility of every Muslim, but it is a responsibility that Muslims do not have
the capacity to perform individually.
However, because IFIs are a collective religious obligation (fard kifayah), the
definition of right and wrong are sometimes of a different nature than those that
apply to individuals. This is because IFIs have a special religious and financial
position in society.
Religiously, IFIs have a responsibility to comply with the form and substance of
Islamic law in all aspects of their operations. This is because they are in a
representative and exemplary religious position, whereby they represent the
interests of their stakeholders and at the same time are exemplars to their
stakeholders. This implies that all aspects of their operations should be conducted
in a permissible or recommended manner while no aspect of their operations
should ideally be conducted in an impermissible or not recommended manner. If it
36 Islamic Economic Studies, Vol. 15, No. 1
Financially, IFIs are intermediaries which mobilize funds from investors and
allocate funds to projects and other investments. In this context, it is the
responsibility of IFIs to mobilize funds from permissible and recommended
sources and invest funds in permissible and recommended projects. Further, IFIs
are also in an exemplary position as financial intermediaries and hence can
significantly impact the conduct of the IFIs stakeholders in terms of the ideal
Islamic investment and allocation process.
It is for these two reasons that IFIs have a contrasted social responsibility to that
of individuals. For instance, individuals have limited capacity to avoid riba in
financial systems that are overwhelmingly based on riba. Hence, IFIs were created
to avoid this form of impermissible activity. This can be extended to recommended
types of activities such as the allocation of funds for the purposes of the benefit of
society or to alleviate poverty. These activities can only be performed in a limited
extent by individuals due to minimal scale economies, but are recommended of
individuals through charity and helping those who are destitute. The overall theme
encouraged by Islam is one of assisting those who are in a relatively disadvantaged
position in society because of circumstances. In this context, IFIs can perform these
functions profitably and efficiently because of the sheer scale of their operations
compared to individuals.
However, it is widely cited that IFIs generally only perform a part of their social
responsibility. As stated above, social responsibility is comprised of a prescription
towards positive (permissible and recommended) actions and a prescription against
negative (impermissible and not recommended) actions. IFIs are widely accused to
have generally ensured their operational status by avoiding negative actions or
impermissible activities, while minimally and variedly conducting recommended
activities.
This may be a function of two overlapping issues. The first issue is that IFIs are
unsure of what is expected of them based on Islam other than to avoid riba and
gharar. In this confusion their approach to social responsibility widely varies based
on individual IFI preferences. The second issue is that, even if it is assumed that
Sayd Farook: On CSR of Islamic Financial Institutions 37
IFIs are conducting their social responsibility activities, they may not be informing
the rest of society through disclosure, leading to an expectations gap. This may be
despite the fact that IFIs are complying to the fullest extent of their abilities with
Islamic notions of social responsibility.
Mandatory forms of social responsibility refer to conduct that the IFI has to
avoid, in its capacity as a representative institution that serves a collective Islamic
religious obligation. These responsibilities, if not carried out will mean that the IFIs
are not complying with fundamental edicts of the Qur’an. This form of social
responsibility does not need a significant expenditure of resources and is within the
reach of all IFIs regardless of their country of origin, legal form or size. This is
because such mandatory forms of social responsibility are mostly prescriptions to
avoid (for e.g. such as riba) rather than prescriptions to act. However, that does not
necessarily mean that the IFI does not have to implement policy and therefore
expend some resources to avoid these actions.
10
Surat Al Baqarah (The Heifer) verse 286.
38 Islamic Economic Studies, Vol. 15, No. 1
Screening of investments
11
Surat Al Baqarah (The Heifer) verse 280.
12
For an in-depth analysis of the substantive intuition behind Islamic laws and their place
in the development of Islamic pre-modern laws, please see El-Gamal (2006).
Sayd Farook: On CSR of Islamic Financial Institutions 39
subsequent effect on the client’s financial and overall well-being. In the event that
ex ante measures are not effective to prevent insolvency of clients perhaps caused
by external economic or personal circumstances, ex post measures should clearly
stipulate the rights and obligations of both parties to the contract, particularly with
regards to the conditions under which late penalties will be charged and under
which conditions IFIs will defer collection of debt. For the purposes of
transparency and fairness to clients, IFIs should also stipulate these conditions to
the client prior to the settlement of any contract.
Employees
Justice forms the core of Qur’anic prescriptions and therefore IFIs must be just
in all its dealings with employees, customers, and all other members of society.
Employees are a vital facet of IFI operations and they are sometimes in an unequal
bargaining position with IFI management. As a result, onerous conditions on the
employees and paltry wages may be characteristic of these situations. The Qur’anic
principle of brotherhood13 is particularly pertinent in the discussion of the treatment
of employees as Muslims treat one another as brothers. This relationship extends to
the working relationships established in IFIs as IFIs are regulated primarily by
Islamic principles. The relationship between employer and employee should
therefore be based on Islamic moral and ethical principles of justice and divine
accountability as applied between Islamic brethren. This places a responsibility on
IFI management to ensure that the employees are treated with justice and that they
are valued regardless of their position in the bank. IFIs therefore should have a
policy on the fair treatment of employees. This policy should encompass providing
an environment free of exploitation and discrimination, free from class or race
barriers and equal opportunity for all based on merit regardless of gender, race,
religion, disability or socio-economic background.
Zakah
13
Surat Al Hujraat (The Apartments) Verse 10.
40 Islamic Economic Studies, Vol. 15, No. 1
need to establish a policy on zakah, unless it is voluntary and they feel it is in the
capacity of the IFI. Hence, the direction taken by AAOIFI in this regard should be
either to supplement the existing standard on zakah to mandate a policy for those
IFIs that have to pay zakah to their government and for those IFIs that voluntary
pay zakah. Alternatively, there should be an ICSR provision which mandates the
establishment of a zakah policy as a mandatory form of ICSR for those IFIs that
have to pay zakah and as a recommended form of ICSR for those IFIs that do not
have to pay zakah.
Qard Hasan
Qard hasan is the only type of loan recognized in Islam. Allah refers to it in the
Qur’an: ‘Who is it that will give Allah a gratuitous loan (qard hasan), which Allah
will double into his credit and multiple many times?’14 It is a gratuitous loan given
to needy people for a fixed period without requiring the payment of interest or
profit. The recipient is only required to repay the principal. As a financial
intermediary, IFIs are in a special position in society to encourage qard hasan
activities both within it and with its clients and customers. This is because IFIs are
able to direct funds from depositors and customers and also allocate them to the
neediest purposes. No other social organization has the opportunity to offer the
specialization in intermediation that IFIs can. For instance, IFIs can open special
qard hasan accounts through which deposits can be received, which would then be
transferred to needy clients such as those unable to pay their dues to banks or
newly married couples unable to purchase household items or students unable to
get an education as a result of financial strife. IFIs can run special fund raising
campaigns to increase their qard hasan funding with minimal marginal expenditure
through the existing infrastructure of the IFI.
14
Surat Al Baqarah (The Heifer) verse 245.
Sayd Farook: On CSR of Islamic Financial Institutions 41
In line with its responsibility to enjoin good and forbid evil in a macro-financial
scale, IFIs are able to implement policies to ensure that investments are directed
towards those industries that are most beneficial to economic development and are
also aligned to Islamic principles of social equity and redistributive justice. IFIs
have a special financial position whereby they are entrusted with funds from
individuals and other organizations. The sheer size of the funds implies that IFIs
are able to utilize economies of scale in investing. To that extent, they are also able
to utilize these economies to invest in ventures that lead to socio-economic
42 Islamic Economic Studies, Vol. 15, No. 1
15
Surat Al Mumenoon (The Believer) Verse 52, Surat Al Anbiya (The Prophets) Verse 52,
Surat Al Hujraat (The Apartments) verse 10
Sayd Farook: On CSR of Islamic Financial Institutions 43
Micro and small sized business and social savings and investments
16
Surat An Nisa (The Women) Verse 86
17
Translation of Sahih Bukhari, Virtues and Merits of the Prophet (pbuh) and his
Companions, Volume 4, Book 56, Number 759
18
For instance, Surat Al Baqarah (The Heifer) Verse 273 or Surat An-Nisa (Women) Verse
436
44 Islamic Economic Studies, Vol. 15, No. 1
Charitable activities
Waqf management
Awqaf (religious endowment) are a vital part of Islamic infrastructure due to the
crucial Islamic services their revenues provide. Because IFIs already have the
technologies to provide efficient financial intermediation, they can play an
important role in securing revenues from awqaf and distributing it to the specified
charitable causes, with minimal marginal outlay.
19
For instance, Surat Al Baqarah (The Heifer) Verses 43, 110, 177, 273, 283.
20
Surah An-Nisa (Women) verse 33.
21
Surah Al-Ala (The Most High) verse 7
Sayd Farook: On CSR of Islamic Financial Institutions 45
even if the IFI has no direct contractual relationship with the individuals. As Maali
et al. (2006) explains, ‘the requirement for Muslims to uncover the truth is
intended to help the community to know the effect of a person or a business on its
wellbeing’ (p.273). It is this social dynamic that makes it essential that IFIs
disclose all relevant information truthfully to its Islamic stakeholders.
Maali et al. (2006) categorizes three broad objectives that are used as the basis
for social responsibility disclosures by Islamic businesses:
This study provides the basis for ICSR for IFIs and the justification for
developing a flexible ICSR standard that encompasses both mandatory and
recommended forms of ICSR. It further provides the accountability foundation for
mandating disclosure of ICSR conduct. Standard setting bodies such as the
AAOIFI have the ability to influence the activities of IFIs by giving them flexible
ICSR provisions that they can adopt depending on their underlying economic
capacity. It is hoped that these standards will provide the impetus, long desired in
the Islamic community, for IFIs to incorporate Islamic social responsibility
principles in all aspects of their activities. To that extent, it is acknowledged that
many IFIs do perform ICSR activities and already have ICSR provisions that are
not recorded or disclosed. It is anticipated that the recommended ICSR standard
will provide a uniform and consolidated basis for IFIs to carry out their ICSR
conduct. Further, it is hoped that the disclosure as recommended here of the ICSR
provisions and ICSR performance of the IFI will fill a long held expectations gap
about what IFI are ‘supposed’ to be doing as Islamic institutions.
46 Islamic Economic Studies, Vol. 15, No. 1
REFERENCES
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Abacus, 42,(2),266-289.
Baydoun, N. and R. Willett (1997), "Islam Ethical Issues in the Presentation of
Financial Information Accounting, Commerce and Finance", The Islamic
Perspective Journal, 1(1).
Shihaddeh, S. (1987), “Financial Accounting Theory from an Islamic Perspective”,
Al-Zahraa, (In Arabic).
Gambling, T. and R. A. A. Karim (1991), Islam and Social Accounting, London:
Mansell Publishers.
El-Gamal, M.A. (2006), Islamic Finance: Law, Economics and Practice, New
York: Cambridge University Press.