Islamic Worldview and Its Implications on Banking and

Finance

� ح�يم الر� ن� ح�م�ـ الر� �ـه� الل � م �س� ب

وف� �م�ع�ر� �ال ب ون� م�ر�� �أ و�ي �ر� ي �خ� ال �ل�ى إ �د�ع�ون� ي م�ة"

� أ �م� م'نك �ن �ك �ت و�ل�ه�و�ن� �ن و�ي

- آیه عمران آل ه�م� . 104سورة �ك� ئ �ـ ول� و�أ �ر� �م�نك ال ع�ن�

�ح�ون� �م�ف�ل ال

The Foundation for Islamic Finance

And let there be [arising] from you a nation inviting to [all that is] good, enjoining what is right and forbidding what is wrong, and those will be the successful. (Qura’an, Al Imran. 3:104).

Islamic Worldview and Islamic Finance

•Islamic worldview has significant influence on all aspects of Muslims’ life (Islam is ad-deen)•Allah describes people who attain success as those who are “inviting to all that is good (khayr), enjoining what is right (ma’ruf) and forbidding what is wrong (munkar) (Qura’an, Al Imran. 3:104).

What is Worldview?

• Vision of reality and truth that appears before one’s mind eye, revealing what existence is all about• Governs way people interpret the world• Schumpeter (1954): Analytic effort is of necessity preceded

by a pre-analytic cognitive act, called vision

• Acikgene (1994): Nature of human mind perceives problem within a scheme of constructive unity

• J. S. Mill (1836): Political economy, therefore, reasons from assumed premises

• Why can’t Muslims rely on conventional worldview? No human endeavor is value free

5FOUNDATION OF ISLAMIC ECONOMICS

Islamic Worldview• Centered on principle of Tawhid or unity of God

• Al-Attas (1978) : “Ru’yat al-Islam Lilwujud” or “The View of Islam About Existence”:

-Man, his aim in life, the universe, way he interacts are all inter-relate

-Man’s behavior governed by rules of Quran and Sunnah

-Pursue material gain with a view that existence in this world and hereafter

-Emphasize the importance of hereafter

6FOUNDATION OF ISLAMIC ECONOMICS

ISLAMIC VS WESTERN WORLDVIEWS• Islamic worldview based on Islam and its sources of knowledge

• A complete worldview at time of revelation-fundamental concepts in Quran are not open for changes in meaning

• Based on revelation; flexible but not replaceable

•Does Islamic worldview different from conventional worldview?• Since factors affecting worldviews differ, it is natural to also have

different worldviews• Different theories to explain human behaviour

•Western: scientific worldview, purely relies on human thinking/logic

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ISLAM IS AD-DIN•Meaning of Islam

• Al-Silm means to surrender, to submit; Salam means peace•Achieve peace by submitting/surrendering oneself to Allah

•Term “din” used to denote “religion” in Qur’an• Comes from root word “dana” mentioned 92 times in Qur’an• Meaning debt, obedience, judgment / way / custom; inter-connected to explain “religion”

• Islam is a way of life• Not limited to rituals/faith• Detailed code of conduct• Willing and conscious submission to Allah in all aspects of life• Economics and its related activities are potentially Ibadah or acts of worship

8

ISLAM IS AD-DIN•Al-Attas (1978) on relationship between din, Islamic worldview and implications on ethics and morality:

•Indebtedness, submissiveness, judicious power, natural inclination•Man is indebted to God for his existence•Man submits himself willingly and consciously to God•Man given the judicious power (aql) that enables him to make decisions•Man born with a natural inclination (fitrah) to submit to God; remembers covenant

•Based on revealed knowledge, man uses his intellect to organize life on earth: Intention and action according to shari’ah

9FOUNDATION OF ISLAMIC ECONOMICS

ISLAM IS AD-DIN•Islam as a complete religion, guides a person’s life in all aspect, moral, social, ethical, economics and political

•God entrusted man with wealth as vicegerent (khalifah) on this earth

•As a khalifiah, man acts as a trustee to God in carrying out his duties fairly towards human being and society following the means permissible by the Shariah

•God has also entrusted man as a custodian of wealth. In order for him to carry out his duties and obligations materially, he has been given the right of possession

10

Al-Islam

Al-Shari’ah

Al-Aqidah(Belief)

Al-Akhlaq(Behaviour)

Al-Fiqh(Jurisprudence)

11

2.Islamic Economic Methodology

Developing Islamic Economics

•Islamic economic and financial disciplines are being developed based on the Islamic economic methodology

-Derive accepted criteria from Islamic worldview

-Judge economic theory from Islamic perspective

-Conduct economic enquiries within Islamic framework

-Reduce/eliminate reliance on western methodology

•Methodology discusses -Process of building models

-Developing theories: validate existing theory or build a new one

-Testing hypothesis

-Establishing and using criteria to evaluate our process• How do we know that our models, theories and hypotheses are correct and on

what authority do we say so

CHANNELS OF ACQUIRING KNOWLEDGE• Primary sources: Divine sources

1. Revelation – the Holy Quran2. Sunnah of the Prophet (saw)

إ��ن ف� � م ك� إ�ن إ� م� ف�� م� ا إ�ي ك�او فو ف� ك�و ف�� ا� ك�وا إ�ي ف�ا فو �ف � ـ ف ا� ك�وا إ�ي ف�ا كنوا ف� آا ف" إ$ي �� ف ا ف%� ك�ي ف�ا ی�إ' مو في م� فوا �إ � ـ ف إ)�� فن كنو إ� م( ك* م ك+ ك,ن إ�ان إ� ك�و ف�� فوا� �إ � ـ ف ا� ف�ى إ�ا ك. ك�/و ك� ف� ء0 مي ف2 إ�ي م ك+ م3 ف4 فن� ف*

ل6ا . إوي م�� ف* ك" ف8 م9 ف�ا فو ر� مي ف; ف> إ� ذف= � إ� إ; آ� م� - ا آیه) النساء (59سورة “O believers, obey Allah and obey the Prophet

and those of you who are in authority. Then if you have a dispute concerning any matter, refer it to Allah and the Prophet if you are the believers in Allah and the Last Day”

• Secondary sources: Human sources1. Ijtihad: interpretation/opinion of

scholars: can be reviewed –ijma consensus

2. Sound senses: perception through five senses; observation

3. Sound reason and intuition: intellect/ ’aql, sound reasoning connected to heart/ qalb /intuition or spiritual heart and intuition

ISLAMIC ECONOMIC METHODOLOGY

•The Quran as guidance in the process of developing Islamic economics and finance•This entails a process of deriving answers based on the sources of Islam

Islamic Worldview Islamic Economic Vision

Islamic Economic Theory

ISLAMIC ECONOMIC METHODOLOGY

Examples1.Based on the Islamic worldview which emphasizes the concept of brotherhood in Islam economic equitability just society distributive justice how zakat can be used in macroeconomic management2.Islamic banking and finance?

Islamic Worldview

Islamic Economic

Vision

Islamic Economic

Theory

SHARI’AH AND

ISLAMIC FINANCE

Islam & Al-Shari’ah

• Shari’ah is guidance in all aspects of Muslim’s life

•Private and public•Individual and social•Spiritual and material•Political, economics and finance

19

Two concepts have important influence on : 1.Tawhidic paradigm2.Concept of vicegerency (Khalifah)

Shariah and Islamic Finance

1. Tawhidic Paradigm•Islam means submitting to the Will of the One and Only God, Allah: concept of tawhid - belief in the oneness of God

•Thus, every discussion of economics, business, ethics and morality is Islam must be of necessity, precede from the tawhidic dimensions

•Tawhid provides the answer to the question on purpose of human existence on earth. Indeed, it is within this tawhidic paradigm that the vision, objectives and fundamental concept of Islam is rooted on

•It presents a picture of the kind of people and society Islam aims to build

•A manifestation of God-consciousness (taqwa)

1. Tawhidic Paradigm Fig 1.1 Position of Economics in Islam Source: Introduction to Islamic Capital Market, p.21

ISLAM

Akhlak (ethics &morality) (

Aqidah (Belief)

Fiqh (Shariah)

Muamalah Ibadah (Worship)

Criminal Law

Family Law

Economics Politics

2. Concept of Vicegerency

•Human beings have been created by Allah as His servant and vicegerents, trustees and representatives on earth

•Thus, objective of human life is to manage and develop the world in accordance with God’s plan, as enshrined by the Shariah, so as to gain goodness in this world and in the Hereafter

•Harmonizes and integrates material well-being with moral-spiritual values

•Man directly responsible and accountable to Allah for all his deeds.

Fig 1.2 Islamic Concept of Vicegerency

Shariah Islamiah

ALLAH

Ibadah Ibadah Concept of Khalifah (Vicegerency)

Individual

Society

Muamalah (Human interaction)

INTERPRETATION OF SHARI’AH ON ISLAMIC FINANCE

•IBF includes justice, fairness and equal distribution of wealth which can be best achieved by means of profit and loss sharing rather than debt financing

•Islamic financial principles share risk and rewards in wealth creation by means of profit and loss sharing

•It promotes entrepreneurship and creativity in the economic cycle whereby individuals put their effort to generate economic activity

•Differs from modern capitalism where profit maximization is the sole motive and bank is broadly content with earning interest for financial gain regardless of real economic activity and social benefits

3.Major Attributes of Islamic

Economics and Islamic Economic System

Basis for IES•In contrast to conventional economics, the Islamic approach to economics is holistic, offers integralistic spiritual view, which is based on the teachings of the Quran and Sunnah, providing a better alternative philosophical framework for man’s interaction with nature and his fellow men.

•Many scholars have defined the activities of Islamic economics as follow:“Islamic economics is the knowledge of the application of the injunctions and rules of the Shari’ah regarding acquisition and

disposal of available resources for providing satisfaction to the individuals in order to enable them individually and collectively to perform their obligations to Allah and the

society.”

1. PHILOSOPHICAL FOUNDATIONS

CONVENTIONAL Economic System

• Derived from theories developed by western scholars

• Specific philosophical foundations1. Concept of scarcity: nature is niggardly and human wants

unlimited

2. Self-interest: priority to individual goals

3. Absolute freedom: survival of the fittest

4. Materialism and utilitarianism

5. Positivism (science) versus norms (religion)

1. PHILOSOPHICAL FOUNDATIONSISLAMIC Economic System

• Derived from Quran and Sunnah

• Specific philosophical foundations

1. Tawhid: Accepting Allah as the only sovereign power

2. Ibadah: Any act must be within shari’ah boundaries to seek Allah’s pleasure

3. Khilafah: Vicegerency, man recognizes his duty as servant of God

4. Tazkiyyah: Process of economic activity must be seen as a process that purifies soul

2. OPERATIONAL PRINCIPLESISLAMIC ES

• Philosophical foundations to a set of operating principles

• Specific operational principles

1. Adl/Ihsan: adl - giving what is due, Ihsan-giving more than what is due

2. Takaful/Taawun: cooperation, brotherhood

3. Responsibility/accountability: individual is responsible to society, but ultimately to Allah

4. Moderation: in consumption, production, distribution

3. GOALS

ISLAMIC ES

• Value loaded, directed towards achieving maqasid al-shariah• Promoting virtues and preventing harm

• To achieve public welfare (maslahah)

• Socio-economic justice

• Economic development

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ISLAMIC ECONOMIC SYSTEMWV

SUB-ST

Phil Op-P Goals

-Tawhid- Ibadah

- Khilafah- Tazkiyah

-‘Adl/Ihsan- Takaful- Resp’ty- Accnt’ty

-S-E Justice- Econ Dev- Efficiency- Stability

EconomicPolitical Social

4. ISLAMIC ECONOMICS

AND FINANCE

33FOUNDATION OF ISLAMIC ECONOMICS

ISLAMIC ECONOMICS

•From definition of Islamic economics•Find values/rules directly in the sources•If not directly available, then have to “derive” the meaning

•Most economic applications will have to be derived

•Need to understand Islamic worldview especially Islamic vision of economics

•Islamic / shari’ah boundaries of economics and finance must be determined•Shari’ah must be interpreted and applied

• Economics: study of human behavior in relation to the use of scarce resource to fulfill unlimited wants

• Economics is a field that deals with management of scarce resources (production, consumption and distribution)

• Due to scarcity, we have to make choices

• Man interacts with other human beings and nature to make these choices

ECONOMICS AND ISLAMIC ECONOMICS

35FOUNDATION OF ISLAMIC ECONOMICS

ISLAMIC ECONOMICS

• Part of din

• Economic activities based on the Islamic worldview

• Make choices and decisions according to Islamic description, analysis, prescription

•Production, consumption and distribution activities

• Approach to and process of interpreting and solving man’s economic problems based on the values, norms, laws and institutions found in and derived from the sources of Islam

36FOUNDATION OF ISLAMIC ECONOMICS

Islamic Economics

•Islam provides unique prescription for economic problems/issues

•Definition: The social science which studies the economic problems of people while incorporating the values of Islam.

Main objective: To achieve falah (Success, happiness & well-being by conforming to Allah’s command)

ISLAMIC ECONOMICS

• Major economic issues• Conventional economics

• Unlimited wants• Limited resources• Achieving the highest utility

• Islamic economics• Economic pursuit must be derived from Islamic worldview • Economic goals do not contradict the shari’ah• Shari’ah constraints to be observed in making choices• Resources are unlimited

38FOUNDATION OF ISLAMIC ECONOMICS

ISLAMIC FINANCE• To finance economic activity in an Islamic framework

• Must have institutions using instrument according to rules and regulations which are all bound by the shari’ah

• Observe basic prohibitions in business transaction: riba, gharar and maysir

• Products involve must be halal

• Profit must come from trading transactions

39FOUNDATION OF ISLAMIC ECONOMICS

Maqasid al-Shari’ah• Objectives and rationale of Shari’ah

– Aims to protect all aspects and segments of life– Faith (ad-din), human self (nafs), intellect (‘aql),

posterity/descendents/generations (nasl) and wealth (mal)– Many shari’ah texts clearly state reasoning behind certain shari’ah rulings– Preserve public interest (maslahah)

• Implications to IBF– Purely financial goals (profit, growth, market share) are insufficient– Profit-sharing vs fixed-return techniques– Need to achieve the objectives of Islamic economics: incorporate spiritual

well-being– distributive justice– cooperation– equitable access to economic resources

Islamic Worldview and Islamic Finance

• In the overall context of Islamic worldview, IBF is established to:

• Requires financial activities which are consistent within shariah guidelines

• follow ethical principles and aim to eradicate all kinds zulm (injustice) which are related to business activities and financial dealings

• contribute significantly to the accomplishment of the socio-economic goals of Islam

Implications on IF

•The goals of the Maqasid al Shariah entail intense commitment of every individuals and organizations to justice, brotherhood and social wellbeing

•This will inevitably lead to a society whereby every member will cooperate with each other and achieve the success in life for ultimate happiness

•In the context of Islamic finance, this means the products offer by financial institutions should reflect ethical values, fairness and justice (Ahmad, 2009)

Implications on IFThe implications on Maqasid al Shariah in IF can be measured based on the extent to which the goals in promoting justice and fairness to individuals and society well being can being achieved. 1.Have religious principles in the Quran and Sunnah of avoiding riba, ghahrar and maysir be observed in product development and transactions between the customers and bank? 2. Has individual need been met fairly met? Is interest still being used in pricing the product?3. Has true knowledge (intellect ) being used to benefit human kind e.g. is the product being developed brings benefit to customers or banks? 4. What is the long term effect of developing the product? Does it benefit individual or further burden them?5. How is wealth being shared between the bank and customers? Is profit sharing being practiced or it is still based on time value of money?

Important Caveat• Conventional knowledge should not be completely rejected

• Common grounds or areas of conventional knowledge which are acceptable to Islam

• Some general concepts can be adopted and amended Economic growth Efficiency Productivity

4.Objectives of Banking and Finance:

Conventional versus Islamic Perspectives

•Objectives of banking and finance from conventional perspectives vs Islamic perspectives

-Motivations to save and borrow-Bank-customer relationship-Overall objectives

Banking and Finance: A Comparative Analysis

Conventional Banks Islamic Banks

1. The functions and operating modes of conventional banks are based on fully manmade principles.

1. The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah.

2. The investor is assured of a predetermined rate of interest.

2. In contrast, it promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur).

3. It aims at maximizing profit without any restriction.

3. It also aims at maximizing profit but subject to Shariah restrictions.

4. It does not deal with Zakat. 4. In the modern Islamic banking system, it has become one of the service-oriented functions of the Islamic banks to be a Zakat Collection Centre and they also pay out their Zakat.

5. Lending money and getting it back with compounding interest is the fundamental function of the conventional banks.

5. Participation in partnership business is the fundamental function of the Islamic banks. So we have to understand our customer’s business very well.

Conventional Banks Islamic Banks

6. It can charge additional money (penalty and compounded interest) in case of defaulters.

6. The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds is given to charity. Rebates are given for early settlement at the Bank’s discretion.

7. Very often it results in the bank’s own interest becoming prominent. It makes no effort to ensure growth with equity.

7. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity.

8. For interest-based commercial banks, borrowing from the money market is relatively easier.

8. For the Islamic banks, it must be based on a Shariah approved underlying transaction.

9. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations.

9. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations.

Conventional Banks Islamic Banks

10. The conventional banks give greater emphasis on credit-worthiness of the clients.

10. The Islamic banks, on the other hand, give greater emphasis on the viability of the projects (prospects of growth of business)

11. The status of a conventional bank, in relation to its clients, is that of creditor and debtors.

11. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller.

12. A conventional bank has to guarantee all its deposits.

12. Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al-wadiah, thus the depositors are guaranteed repayment of their funds, however if the account is based on the mudarabah concept, client have to share in a loss position.

•Haron and Azmi (2009)•Haneef (1997)•Zaharuddin.net

References