The Future of Islamic Finance: Between Shariah Principles and Innovation

Habib AhmedSharjah Chair in Islamic Law & Finance

Durham University Business School

United Kingdom

Outline

• Introduction: The Context

• Shariah Principles

• Innovation Dimensions: Domains and Intensities

• Islamic Finance & Innovation

– Framework and Assessment

– Case Studies

• The Way Forward

Introduction: The Context • United Nations launched Sustainable Development

Goals (SDGs) in 2015 to achieve 17 goals by 2030

• At current levels of investments developing countries will face a gap of $2.5 trillion annually to achieve SDGs(UNCTAD 2014)

• The financial sector has an important role to fill the gap and promote SDGs– Increase financial access and inclusion for individuals

(SDGs1, 2, 3, 4, 10), SMEs (SDGs 5, 8) and governments (SDG 13)

– Help generate resources for investment in renewable energy (SDGs 6, 13) and infrastructure projects (SDGs 6, 9)

Economic Status of OIC/IsDB MCs

• 57 IsDB member countries – Population—1.8 billion (23.7% of the world population)– GDP—US$6.4 trillion (8.2% of the global GDP) – 700 million people living under US$ 2 a day (World Bank

2014)

• Would require huge investments to achieve the SDGs• Financial inclusion (voluntary) would require Shariah

compliant financing• Looking forward, what has Islamic finance to offer to

contribute to the SDGs (financial inclusion)?

Financial Services and Financial Inclusion/Exclusion

• Developing countries– 7% of people borrowed from a financial institution (6% for the

bottom 40% of the income group) (Findex 2017)– 40% of MSEs (65 million) have unmet financing needs amounting to

US$5.2 trillion annually (IFC 2017)– Islamic micro finance is 0.5% of the total microfinance outreach

(Karim et. al. 2008)

Financial Functions/ProductsHousehold sector Business Sector

Poor(1)

Non-poor(2)

MSEs(3)

MLFs(4)

Mobilizing savings/asset management (MS)

MS1(?) MS2(√) MS3(?) MS4(√)

Allocating capital/financing (AC)

AC1(?) AC2(√) AC3(?) AC4(√)

Managing risks (MR) MR1(?) MR2(√) MR3(?) MR4(√)

Islamic Finance—Vision • Islamic economists—economy based on Islamic

principles will fulfill the maqasid al Shari’ah– Produce a vibrant and stable economy balancing equity

and growth– Financial system would be Shari’ah compliant, ethical,

inclusive, resilient and promote social and economic development

• Islamic finance has had high quantitative growth rates, but questions raised about its quality– Too much focus of legal compliance– Social/ethical goals not achieved

• Achieving SDGs implies focusing more of social goals

6

Outline

• Introduction: The Context

• Shariah Principles

• Innovation Dimensions: Domains and Intensities

• Islamic Finance & Innovation

– Framework and Assessment

– Case Studies

• The Way Forward

8

Islamic Finance and Shariah Principles• Shariah principles

– Shariah compliant: fulfilling the legal form

– Shariah based: fulfilling the legal form/substance and maqasid

Maqasid ammah (macro/general)• Macro/General: realizing human

wellbeing by enhancing welfare (maslahah) and preventing harm (mafsadah)

• Produce an economy that protects ‘public interests’, balances between growth and equity

Maqasid khassah (micro/specific)• Protecting and enhancing five

essentials (faith, life, intellect, posterity and wealth) of the stakeholders

• Fulfilling the objectives stipulated in contacts

Innovation Dimensions

Domains of Innovation Intensities of Innovation

• Organizational • Markets• Meanings

• Incremental (or sustaining): simple/minor changes that improve existing products

• Radical (or disruptive): change of frame that produces new and discontinuous outcomes

Innovations in Organizational and Market Domains

Innovation Domains Incremental Radical

OrganizationalSupply side innovations in technology, business models and processes

Existing firms providing better services, simple and incremental improvements by better technology, business models or processes

Novel and unique breakthroughs implying discontinuity with the past

MarketsUser or demand side

Innovations in products and services in existing established markets

Targeting un-served new markets that are less profitable and not served by incumbent firms

Innovations in Meanings Domain

• Relates to ‘purpose’ of the product perceived by the user—‘why’ people use/need a product

• Are intangible and depends on socio-cultural context in which products are used

• Output--new meaning relating to symbolic and emotional factors

• Changes lead to new meaningful culturally embedded experiences to the user

• Constructed with interactions with the society and co-created by firms and users

• Incremental: minor changes in existing meanings in products and services

• Radical: redefinition of socio-cultural paradigm resulting in products that are new and different from the dominant meaning in existing markets

Meaning?

Innovation of Meaning?

Innovation Intensities

Outline

• Introduction: The Context

• Shariah Principles

• Innovation Dimensions: Domains and Intensities

• Islamic Finance & Innovation

– Framework and Assessment

– Case Studies

• The Way Forward

Dimensions of Innovations

Islamic Finance and Innovation: Assessment Framework

Innovation Domain

Incremental

(Index value: 1)

Radical

(Index value: 2)Organizational Imitating existing organizational

formats of conventional financeDeveloping innovative organizational models reflecting Islamic values and principles

Market Targeting clients in existing markets (non-poor and MLFs)

Targeting clients in markets that are not served (poor and MSEs)

Meaning Legal Shariah compliance (form/ substance) but ignoring the maqasid

Shariah compliance in form (Index: 0.5)

Legal Shariah compliance (form/substance) and fulfilling maqasid (ethical and social goals)

Islamic Finance and MeaningStakeholders’ Expectationsa

(477 respondents in Malaysia)

Islamic Banks Concernsb

(103 CEOs from 31 Countries)

Objectives Score* Concerns Score* (Rank)

Provide Shariah

compliant products4.60

Shareholders’ Value &

Expectations4.35 (1)

Promote sustainable

development4.13

Consumer Attraction, Relation

& Retention4.26 (6)

Contribute to social

welfare4.07

Shariah standards, compliance and governance framework

4.16 (8)

Maximising profits 3.76

Financial Inclusion, Micro &

SME Financing3.67 (18)

*Score--average of responses with the following weights: Not important at all-1; Not important-2; Do not know-3; Important-4; and Very important-5. Source: a-Nor (2012); b-CIBAFI (2018)

16

Practice of Islamic FinanceSummary of Empirical Studies

Research Papers Shariahcompliance

Stakeholders CharitableActivities

Social & Environmental Impact

Kamla & Rammal(2013) (19 banks)

Good Moderate Insignificant

Haniffa & Hudaib(2007) (7 banks)

Good Good Insignificant

Maali et. al. (2006) (29 banks)

Good Moderate Moderate Insignificant

Mohammed & Razak(2008) (6 banks)

Insignificant

Aribi & Arun (2015)(7 financial institutions)

Good Insignificant Good None

CONCLUSION GOOD MODORATE GOOD/MOD. INSIGNIFICANT

Innovations in Organizational Formats

• Islamic banking model – Meaning: Incremental– Organizational:

Incremental – Market: Incremental

• Baitul maal wa Tamwil– Organizational: Radical– Market: Radical– Meaning: Radical

0

0.5

1

1.5

2

MeaningInnovation

OrganizationalInnovation

MarketInnovation

Islamic Banking Model

Baitul Maal wa Tamwil

Financing Instruments Innovations

• Tawarruq based cash financing (existing clients)– Meaning: Incremental– Organizational: Incremental – Market: Incremental

• Islamic banks providing microfinance– Meaning: Radical– Organizational: Incremental– Market: Radical

0

0.5

1

1.5

2

MeaningInnovation

OrganizationalInnovation

MarketInnovation

Tawarruq-based cash financing to exiting clients

Islamic banks providing microfinance

Islamic Investment Instruments Innovations

• Traditional Shariah Compliant Mutual Fund– Meaning: Incremental (negative

screening)– Organizational: Incremental – Market: Incremental

• Shariah Compliant Inclusive Mutual Fund– Meaning: Incremental– Organizational: Incremental– Market: Radical

• Sustainable Islamic Investment Fintech for low income households– Meaning: Radical– Organizational: Radical– Market: Radical

0

0.5

1

1.5

2

MeaningInnovation

OrganizationalInnovation

MarketInnovation

Taditional Shariah Compliant Mutual Fund

Shariah Compliant Inclusive Mutual Fund

Sustainable Islamic Investment Fintech for Low IncomeHouseholds

Outline

• Introduction: The Context

• Shariah Principles

• Innovation Dimensions: Domains and Intensities

• Islamic Finance & Innovation

– Framework and Assessment

– Case Studies

• The Way Forward

The Future and Islamic Finance

• Achieving the SDGs—a huge challenge

• Accelerators shaping the future—technology, climate change and globalization

• Presents both risks and opportunities

• Islamic finance principles can positively contribute SDGs(financial inclusion) and enhance resilience in financial systems

• Need to come out of straightjacket of incremental innovations of imitating conventional finance

• Starting point: Shift from the incremental to radical innovation of meanings

The Future?

How can Islamic Finance

respond?

Islamic Finance—the Way Forward

Consider both means (contracts) and ends (maqasid)

Change in mind-set about radical meanings will induce different types of innovations

• Providing financial services to the poorer households and MSEs will be explored (radical market innovations)

• This would require using non-bank financial institutions (fintechs) to provide the services (radical organizational innovations)

Radical Innovations of

Meanings

Potential Innovations

An Example: myAgro

The Story of myAgro

Anushka Ratnayake worked with Kiva.org and One Acre Fund

Noticed that farmers had adequate funds during harvest time but these got exhausted during the time for planting

Could not buy seeds and fertilizers for the next round of crops

7% small farmers had access to loans and could buy seeds/fertilizers

Low levels of production led to many families not being able to feed themselves over the year

Those who got loans had to pay off the loans during harvest time and take a new round of loan during the plantation time

myAgro...

Anuskha initiated a micro-savings program myAgro in Mali in 2011

• Established a mobile layaway platform

• Farmers could save by buying mobile phone-time (mobile scratch cards) during harvest time and transfer funds to myAgro’s account.

• During the planting time, the seeds and fertilisers that are already paid for are delivered to farmers

• myAgro started operating in Senegal also and planning to start operations in Tanzania in 2018

• Farmers who participated increased their annual income by 50-100%.

• The scheme has 50,000 clients in 2018 and the goal is to reach a million small farmers by 2025 and double their income levels

The Framework

The Results

Salam- Linked Innovations

• Salam-based personal financing– Meaning : Incremental– Organizational: incremental – Market: incremental

• Salam Financing Farmers– Meaning: Incremental– Organizational: Incremental– Market: Radical

• myAgro Micro-Savings Scheme– Meaning: Radical– Organizational: Radical– Market: Radical

0

0.5

1

1.5

2

MeaningInnovation

OrganizationalInnovation

MarketInnovation

Salam-based Personal Financing

Salam Financing Farmers

myAgro Micro-savings Scheme

THANK YOU!habib.ahmed@durham.ac.uk