Somalilandsun – Microfinance is a novel method for human-oriented economic development and a capacity-building tool, which easily fits into the Islamic banking and finance (IBF) paradigm through social responsibility.
Islamic banking and finance (IBF) is a value-oriented ethical proposition; the principles of IBF can be located in the principles and norms of Islamic moral economy (IME), which aims at human-centered economic development as opposed to the financialization of the economy.
Social responsibility is an essential part of IBF; however, IBF institutions have been criticized for their social failure.
Microfinance is a novel method for human-oriented economic development and a capacity-building tool, which easily fits into the IBF paradigm through social responsibility.
The financial instruments of IBF and IME institutions can provide an important base for the development and progress of Islamic microfinance (IMF), which fulfills the aspirations of developing communities in an Islamic way.
A number of IBF institutions have demonstrated success in IMF, particularly by overcoming the burden of interest on the poor and expanding the asset base.
Rationalizing Islamic Microfinance through Essentializing the Islamic Moral Economy
Islamic banking and finance (IBF) has become a mainstream financing method utilized by Islamic, as well as conventional, banking and financial institutions all over the world. Recently, however, IBF has been criticized for its social failure, in the sense that its operations are not different from the existing conventional tools minus the interest. An essential nature of this criticism is related to the foundational axioms and principles of IME which, as a worldview, is based on the authentic principles of Islam. Thus, IME is an authentic response to the failure of economic developmentalism in the Muslim world in constructing a human-centered development. In this attempt, IBF was considered as the financing and operational tool of the new paradigm, and consequently it is expected to fulfill the expectations and aspirational paradigm of IME.
The foundational principles and axioms of IME aimed at revealing the principles behind IBF through an ethical worldview are:
• vertical ethicality in terms of individuals as the creature of God being equal (tawhid);
• social justice and beneficence (adalah and ihsan) in terms of horizontal ethicality;
• growth in harmony (tazkiyah);
• allowing the social (individual and society) and natural environment to reach to and sustain its perfection (rububiyah);
• voluntary action but also compulsory action (fard) in serving the social interest;
• individuals, being the vicegerent of God on Earth (khalifah), are expected to fulfill and act according to these principles in their economic and financial behavior.
These foundational principles are justified by a particular methodological understanding; the maqasid al-shariah (objectives of shariah) are interpreted as human well-being, which, in this context, is achieved through a socially operating moral economy in an Islamic framework that is expected to produce a socially and economic-financially optimum solution in overcoming the socioeconomic problems of a society.
Ethical Objective Functions of Islamic Finance
As part of this ethical economic paradigm, IBF is expected to operate within such an objective function and framework to establish the optimality between financial operations and social objectives (as a morally identified objective function). To operationalize the ethical objective in IBF, further principles are developed through the ontological sources of Islam. These principles, which aim to promote an ethical and socially oriented way of “doing finance,” are as follows.
• Prohibition of interest (or riba) with the objective of providing a stable and socially efficient economic environment.
• Prohibition of fixed return on nominal transactions, with the objective of creating productive economic activity or asset-based financing over the debt-based system.
• In this moral economy, money does not have any inherent value in itself and therefore it cannot be created through the credit system.
• The principle of profit and loss sharing, and hence risk sharing, is the essential axis around which economic and business activity takes place. This prevents the capital owner from shifting the entire risk on to the borrower, and hence it aims to establish a just balance between effort and return, and between effort and capital. This axiom identifies the essential nature of Islamic microfinance.
• An important consequence of the profit/loss sharing principle is the participatory nature of economic and business activity, as IBF instruments, capital, and labor merge to establish partnerships through their individual contributions which, as a principle, constitutes the fundamental nature of microfinance.
• By essentializing productive economic and business activity, uncertainty, speculation, and gambling are also prohibited, with the same rationale of emphasizing asset-based productive economic activity.
As can be seen, each of these principles, together with the above-mentioned axioms, provide rationale as to why microfinancing is an essential part of IME and, hence, IBF. The following description of IBF in terms of institutional and operational features provides further rationale as to why microfinance is inherently Islamic in its nature (Khan, 2007).
• It is a form of community banking aiming at serving communities, not markets;
• It offers responsible finance, as it runs systematic checks on finance providers and restrains consumer indebtedness; it also offers ethical investments and corporate social responsibility (CSR) initiatives;
• It represents an alternative paradigm in terms of stability by linking financial services to the productive, real economy; it provides a moral compass for capitalism;
• It fulfills aspirations in the sense that it widens the ownership base of society and offers success with authenticity.
As these principles indicate, IBF should serve social interests (for example, through microfinance) in establishing its financial optimality such that it offers ethical and social solutions to development in Muslim and developing countries.
While IBF has been criticized for not fulfilling these principles in its current practice due to its adoption of a commercial banking structure, it can be seen that it has the potential to respond to the social objective, which is an inherent function of Islamic finance.
In helping IBF to demonstrate its original ethical and social nature, new methods of financing can be developed to appeal to their commercial nature as well. Since, by definition, IBF institutions are nevertheless expected to contribute to social development, they have to move to the third institutionalization stage (the first stage was social banking in the 1960s, followed by commercial banking as the second institutional phase from the mid-1970s until now), in which society and capacity building-oriented institutions, such as microfinancing and social banking, should run alongside the commercial banks. This fulfills the social and ethical expectations as identified by IME, but also responds to the development needs of the societies in which they are operating.
A financial system should be able to provide financing to different segments of a given society such that, in addition to financial and economic objectives, social objectives may be served. Since social objectives are an essential part of the IME, it is imperative for IBF to fulfill such objectives alongside their business interests. As a social and moral method of financing, IBF, therefore, should contribute directly to economic and social development. This can become possible through social banking and microfinance, though it should be recalled that the initial experience of IBF in the early 1960s in Egypt was a social bank that was microfinancing-oriented.
Due to the complementarity between IBF and microfinance, there is a need to see further and proactive involvement of IBF and nonbanking Islamic institutions to provide IMF.
By using the essential methods and instruments outlined here, authentic models of IMF can be developed that will ensure the proactive development and efficient running of microfinancing, so that self-sustaining and human-centered development, aimed at helping poor individuals and entrepreneurs who are excluded from economic and financial life, can be achieved as expected by IME by also creating social capital.
The author Abdiqani Ahmed Hassan is a Lecturer, University of Hargeisa