Islamic Banking


After fourteen centuries of Islam appearance the Western culture and values dominated for many centuries on the financial and economic aspects, there has been a revival of Islamic principles and values in Muslim countries. This revival was a result of a growing dissatisfaction among the Muslims with the values of the West. As a result there were dissatisfaction concerns for the conventional banking practices present in these Muslim countries. Because the conventional banks were involved in the collection and charging of interest (riba) which is prohibited (haram) in Islam.

According to (Haqiqi & Pomeranz, 2005) 'The desirability of abolishing fixed interest rates and the Islamization of financial systems' is one of the main reasons for the establishment of Islamic banks. Islamic financial institutions especially Islamic banks are supposed to adhere strictly with the precepts of the Shari'ah', the Islamic code of law 'derived from the Holy Qur'an, Hadith of the Prophet Muhammad (Peace be upon him), and juristic reasoning (ijtihad) of Islamic scholars' (Kamali, 2000). Due to the prohibition of interest in Islam, they could not offer conventional financial services and had to offer those in compliance with the Shari'ah. Examples of such services include Mudarabah, Musharakah, and Ijarah. The profit is a part of its goals, it isn't the most important goal for Islamic banks, whereas the goal of conventional banks is to make as much profit as possible and at any means.

Imam Ghazali (as cited by Dusuki n.d.) states that 'the objective of the Shari'ah is to promote the well-being of all mankind, which lies in safeguarding their faith (din), their human self (nafs), their intellect ('aql), their posterity (nasl) and their wealth (mal). Whatever ensures the safety of these five serves public interest and is desirable'. From these objectives of the Shari'ah, it can be understand the goal of an Islamic bank and gathered that the most important role of Islamic banks is to promote the betterment of the society in which they are set up by providing means by which members of the society can better themselves, particularly improving their posterity and wealth.
Allah says in the Holy Quran, 'O you who believe, why do you say that which you do not do? Greviously odious is it in the sight of Allah that you say that you do not do.' ( as-Saff: 2-3) and the researchers' study had as a goal, a determination of whether Islamic banks in Malaysia were fulfilling their claim of complying with the Shari'ah by comparing their disclosures as reported in their annual reports against an ideal level of disclosure as measured by the 'Ethical Identity Index' developed by (Haniffa & Hudaib, 2007). This paper will be organized as follows: introduction, literature review, research methodology, analysis and discussion of results, overview of findings and implications.

LITERATURE REVIEW

Theories and Practices

Islamic banking is banking based on Islamic law (Shariah). It follows the Shariah, called 'qh muamalat (Islamic rules on transactions). The rules and practices of 'qh muamalat came from the Quran and the Sunnah, and other secondary sources of Islamic law such as opinions collectively agreed among Shariah scholars (ijma'), analogy (qiyas) and personal reasoning (ijtihad). Islamic banking refers to a system of banking activity that is in conformance with the Islamic law (Shari'ah) in all aspects. 'Among other things, Shari'ah prohibits dealing in interest and undertaking transactions with unknown fate, while it requires transactions to be lawful (halal), and also requires Muslims to pay the religious [levy] Zak??t, Abolishing interest from their dealings is the fundamental principle on which Islamic banks are based' (Maali, Casson, & Napier, 2003)

The ultimate objective of conventional banks is profit maximization, which is in line with the Capitalist worldview on which these banks are founded upon. This situation is not so for Islamic banks as they are founded on the basis of the religion of Islam. Although, banks are viewed as separate and legal entities unto themselves, in reality they are run by human beings. Islamic banks are thus run by Muslims, and the ultimate objective of a true Muslim is to be successful in this world and the Hereafter by pleasing Almighty Allah in all his affairs. With this reasoning, the Islamic banks also possess this as their ultimate objective. This is not to say that profit is not a major objective of Islamic banks; on the contrary, Islamic bank managers are expect to strive earnestly to make a reasonable profit for its depositors and shareholders, but all the while adhering to the principles of Islam in all their dealings (Haniffa & Hudaib, 2007; Maali et al., 2003). So unlike conventional banks, profit maximization is not the primary objectives of Islamic banks, as they 'have to incorporate both profit and morality into their objectives' (Haron, 1997b)

Social justice plays a vital role in developing a society as exemplified by the betterment of the whole society is a concept that is mandated for all Muslims. It is clearly said in Holy Quran as following:
'We send our Messengers with clear signs and sent down with them the Book and the Balance (Right and Wrong), that men may stand forth in justice' (Al-hadid: 25).

'O ye who believe! Eat not up your property among yourselves in vanities: But let there be amongst you Traffic and trade by mutual good-will: Nor kill (or destroy) yourselves: for verily Allah hath been to you Most Merciful!' (An-Nisa: 29).

Islamic banks thus have to obtain a balance between earning and spending in order to achieve this noble target of betterment of the whole society. As regards the concept of equity, in Islam it is understood that absolute ownership of everything belongs to Allah, and in His infinite wisdom he allocates resources to people in varying degrees. The following verse of the Holy Qur'an illustrates this absolute ownership of Allah:

'To Allah belongeth the dominion of the heavens and the earth; And Allah hath power over all things' (Al-Imran: 189).

For this reason, it is expected that those apportioned with more resources than others understand that they have a responsibility of helping others less fortunate than them. Allah says:

'And in their wealth and possessions (was remembered) the right of the (needy), him who asked, and him who (for some reason) was prevented' (Adh-Dhaariyat: 19).

The implication of the above verses for Islamic banks is that 'while making profit from business is allowable in Islam, the accumulation of profit without utilization for the betterment of the community is forbidden' Islamic banks are expected to be more sensitive to the needs of society, promote more social programs and activities, and make contributions towards the needy and poor families' (Haron, 1997a)
The Shari'ah prohibits the involvement with interest in very strong terms as is evidenced by the following verses of the Holy Quran:

'Those who eat Riba (usury) will not stand (on the Day of Resurrection) except like the standing of a person beaten by Shaitan (Satan) leading him to insanity. That is because they say: "Trading is only like Riba (usury)," whereas Allah has permitted trading and forbidden Riba (usury). So whosoever receives an admonition from his Lord and stops eating Riba (usury) shall not be punished for the past; his case is for Allah (to judge); but whoever returns [to Riba (usury)], such are the dwellers of the Fire - they will abide therein'.(al-baqara:275)

'That they took Riba (usury), though they were forbidden and that they devoured men's substance wrongfully ' We have prepared for those among men who reject faith a grievous punishment.' (An-Nisa: 161)
'That which ye lay out for increase through the property of (other) people, will have no increase with Allah: But that which ye lay out for charity, seeking the countenance of Allah (will increase): it is these who will get a recompense multiplied'. (Ar-Rum: 39)

This prohibition forces Islamic banks to pursue other avenues of business transactions that are in line with the Shari'ah. (Haron, 1997a)states can be classified into three principles:

1) Profit and loss sharing

Mudaraba and Musharaka are the two most common modes of financing under this principle currently in use by Islamic banks. Mudaraba is an agreement between an investor or capital provider (rabb al-mal) and an agent or entrepreneur (mudarib), where the mudarib invests the funds in a project. The profit is shared between the two parties based on a predetermined ratio, while all loses are borne by the rabb al-mal. (Chiu & Newberger, 2006). Musharaka is an equity participation contract whereby the bank and its clients contribute funds to engage in a project. Profits and losses are usually distributed based on proportion of funds contributed. It is in effect a partnership where both parties share in profit as well as losses (Chiu & Newberger, 2006; Qorchi, 2005; Wilson, 2007). These two principles of Mudaraba and Musharaka which permit risk-sharing between the banks and its clients are viewed as strongly Islamic in a consensus among Muslim scholars, as they conform to Islamic objectives in both form and substance (Haron, 1997a). Unfortunately, most Islamic banks focus more on fees or charges based principles as they most strongly resemble the conventional mode of charging interests (Haniffa & Hudaib, 2007; Maali et al., 2003).

2) Fees or charges based

This principle refers to debt-based transactions, the most popular of which is the Murabaha. Murabaha which is the most widely used financing method used by Islamic banks today, involves a bank purchasing a good required by a customer and then re-selling the good to the customer at a pre-determined profit. The customer agrees to pay for the good over a given period in installments (Pollard & Samers, 2007). To be truly in line with Islamic principles, the bank must take actual ownership of the good before reselling it to the client. However the practice today in Islamic banks more closely resembles conventional interest-based financing whereby the bank does not take actual ownership of the good in question, but rather advances the client with the money to purchase the good, and which the client pays back over time with an added amount which the Islamic banks call profit but in reality is considered a 'back door' to interest (Dusuki & Nurdianawati, 2007). This is why some scholars refer to debt-based principles as weakly Islamic as actual practice is Islamic in form but not in substance (Haron, 1997a)

3) Free services
These principles reflect the social role that Islamic banks are expected to play as expounded by the Shari'ah, with the ultimate goal of betterment of society thorough their activities. This principle is manifested mainly through the provision of interest-free loans known as Qard hasan to those clients most in need of such funds (Haniffa & Hudaib, 2007; Pollard & Samers, 2007). 'All Islamic banks have a Shari'ah Supervisory Board (SSB) whose role is to ensure that any new formulations and modalities are in line with Shari'ah principles and within the ambit of Islamic norms' (Haniffa & Hudaib, 2007).The SSB usually comprises eminent scholars of the area, and although they are hired by the bank management, they are considered to be independent and possess the authority to sanction or reject any proposals made by the bank management in light of Islamic law (Dar, 2000). Usually contained along with an Islamic Bank's annual report, the SSB are required to confirm the discharge of the functions by providing a Shari'ah report. This report provides the bank's stakeholders with an assurance on whether or not the bank complied with the Shari'ah in all its dealings, and in instances of noncompliance, discloses where the noncompliance occurred, why it occurred, and what steps are taken to make sure it never occurs again.

Theories of Social Reporting (SR)
social reporting is defined as 'the provision of financial and non-financial information relating to an organization's interaction with its physical and social environment, as stated in corporate annual reports or separate social reports' (Kemp & Vinke, 2012)
Driven by recent business scandals around the world such as Enron, WorldCom and Parmalat, just to name a few, there has being growing interest in corporate, environmental and social reporting for achieving better corporate accountability (Hess, 2007). Proponents of social reporting also argue 'that organizational transparency through social reporting is the key to meaningful stakeholder engagement' (Hess, 2007).

The SR literature provides various theories propounded to explain the motivation for disclosing social information by firms and the particular set of stakeholders for whom such social information is provided for.
The more prominent theories are as follows:

1. Legitimacy theory

Legitimacy theory implies that given a growth in community awareness and concern, firms will take measures to ensure their activities and performance are acceptable to the community In other words, the legitimacy theory as related to social disclosure implies that the reason why companies disclose their environmental activities is because it is required by the community in which they operate, and failure to disclose could have adverse implications for the company (Campbell, Craven, & Shrives, 2003; Milne & Patten, 2002; Moerman & Van Der Laan, 2005; Nik Ahmad & Sulaiman, 2004; Wilmshurst & Frost, 2000). many studies employed the legitimacy theory to investigate the influence of particular incidents or disasters, such as an oil spill, on the corporate social and environmental reporting, and found that this reporting has been increased after these incidents, reflecting the view that management uses annual reports as a tool to manage the impact of unfavorable incidences on the corporation's reputation (Deegan, Rankin, & Tobin, 2002).

2. Decision Usefulness Approach

This approach dictates that firms disclose voluntary information because they are useful for stakeholders. This theory was adopted to explain the motivations for companies' disclosure of voluntary social information. The decision usefulness approach propounds that firms provides social disclosures because they are deemed useful for stakeholders (Boesso & Kumar, 2007; Campbell & Beck, 2004; Campbell, Moore, & Shrives, 2006; O'Dwyer & Bradley, 2005; Solomon & Solomon, 2006). For example, (Campbell et al., 2006) explores 'community disclosures in annual reports examining annual reports for 5 UK FTSE 100 sectors between, 1974 and 2000'. Their findings suggested that community disclosure was positively associated with public profile. These findings were consistent with 'reporting behavior found in other categories of voluntary disclosure, where disclosure has being found to be associated with the presumed information demands of specific stakeholders' (Campbell et al., 2006). Emphasis added.

3. Stakeholder Theory
A stakeholder is defined by some researchers as any group or individual who can affect or is affected by the corporation (Freeman, 1983). A stakeholders' list extends to include, in addition to traditional groups (i.e. owners and creditors), other individuals and groups in society such as local community, customers, employees, suppliers, government, trade unions, and societies of environmental protection. And even society at large. Applying this theory to social reporting, it implies that a firm will disclose social information as part of a dialogue between itself and its stakeholders (Maali et al., 2003). In other words, stakeholder theory views social disclosure as a response to significant pressures from a firm's external environment. Apart from the investment community, such pressures may arise from pressure groups or the general public (Belal & Owen, 2007; Brammer & Pavelin, 2006; Danastas & Gardenne, 2006; Hess, 2007). 'Social reporting takes place within a framework of social relations. Fundamental to an Islamic perspective on social reporting is an understanding of the concepts of accountability, social justice and ownership that are central to social relations' (Maali et al., 2003).

1. Accountability

A wider accountability dictates that the company should be accountable to a wide range of different interest groups (i.e. government departments and agencies, employees, local communities and consumers), and even to society as a whole (Mathews, 1997). The Western concept of accountability is usually restricted to organization's stakeholders as can be seen in the following definition of this concept: 'Accountability refers to the process through which an organization makes a commitment to balance the needs of stakeholders in its decision-making processes and activities, and delivers against this commitment' (Zubairu, Sakariyau, & Dauda, 1997).
This concept is restricted to the human realm when envisioned from the Western viewpoint; however, from the Islamic viewpoint the concept is much broader and transcends the human realm. In Islam, accountability is first and foremost to Almighty Allah.

'On that Day will men proceed in companies sorted out, to be shown the deeds that they (had done). Then shall anyone who has done an atom's weight of good, see it! And anyone who has done an atom's weight of evil, shall see it' (Az-Zalzalah: 6-8).

The verse of the Holy Quran above captures in a nutshell the concept of accountability in Islam. Allah has provided for mankind various resources and blessings, too numerous to count. Man is expected to use these blessings in the service of Allah, and on the Day of Resurrection, each man shall have to give an account on how he used these blessings. He who used these blessings in the service of Allah is rewarded with Paradise and he who does otherwise is doomed to Hellfire. This awareness is supposed to drive the action of each and every Muslim at all times in all aspects of life, be it personal or business, and in his or her dealings with others as well. It can thus be said that 'accountability to God implies accountability to society'(Maali et al., 2003).

Drawing on the work of (Al-Khater & Naser, 2003) the accountability process can form a useful basis for corporate reporting in the emerging economies, if it observes the following:
1. The accountability process should be viewed as a social, and not only as an economic Concept. The find providers' needs should not be seen as being more important than those of other users of corporate information.
2. The accountability process should be viewed as a mechanism that lays down the ethical foundations for accounting and assures the fairness and public interest within this framework
3. The accountability process should emphasize the notion of the right to know.

2. Social Justice

'Social justice means giving each individual what he/she deserves in the distribution of financial benefits in the society, and providing equally for basic needs. It is also the egalitarianism in opportunities, i.e. each person has a chance to climb up the social ladder' ('Social Justice in Islam', n.d.). Social justice is critical for the development of a moral and justice society, and for this reason is greatly emphasized in Islam, as evidenced by the following verses of the Holy Quran:

Allah doth command you to render back your Trusts to those to whom they are due; and when ye judge between man and man, that ye judge with justice: Verily how excellent is the teaching which He giveth you! For Allah is He Who heareth and seeth all things (an-Nisa: 58).

O ye who believe! Stand out firmly for Allah, as witnesses to fair dealing, and let not the hatred of others to you make you swerve to wrong and depart from justice. Be just: that is next to piety: and fear Allah. For Allah is well-acquainted with all that ye do (Al-Ma'idah: 9).

The prohibition of Riba to prevent exploitation of people, the imposition of Zak??t to help alleviate poverty in the society, and the recommendation to help others through charity, are all examples of Islam's emphasis on social justice.

3. Ownership and Trust

Allah is the ultimate owner of everything and man has being entrusted with resources as a trust to be used in accordance with the commands of Allah. This concept is closely linked to the concept of accountability as it is for these entrusted resources that each man has to account for on the Day of Resurrection. The following verse of the Holy Qur'an illustrates this absolute ownership of Allah:

'To Allah belongeth the dominion of the heavens and the earth; And Allah hath power over all things' (Al-Imran: 189).

This concept for an Islamic business is that its resources must be used in accordance with the commandments of Allah and for the benefit of society. It can thus be concluded that the three concepts of accountability, social justice and ownership are interlinked and co-dependent; One cannot exist without the others.

RESEARCH METHODOLOGY

Research Method

The study adopts as a guide the study carried out by (Haniffa & Hudaib, 2007), which sought to explore the ethical identity of Islamic banks as communicated via annual reports.

The study sought to discover the social reporting practices of Islamic banks in Yemen. To achieve this objective, content analysis was utilized in order to examine the annual reports of the selected Islamic banks. Content analysis was selected as research method for the study because it is 'a research technique for making replicable and valid inferences from texts to the content of their uses. As a research technique, content analysis provides new insight, increases a researchers understanding of new phenomena, or informs practical action. Content analysis is a scientific tool' (Krippendorff, 2012).
In many previous social disclosure studies, content analysis has been the method of choice for determining the extent of an organization's social disclosures through whatever media of communication; whether annual reports (Boesso & Kumar, 2007; Gruning, 2007; Maali et al., 2003), company websites (Branco & Rodrigues, 2006; Holcomb, Upchurch, & Okumus, 2007) or any other media. This widespread use of this method by previous social reporting literature is another reason why content analysis was chosen as the research method by the researchers. To determine whether or not Islamic banks in Yemen were fulfilling the Shari'ah requirement of full disclosure, a checklist of items that Islamic banks ought to disclose was developed. This checklist was adopted from two studies, (Haniffa & Hudaib, 2007; Maali et al., 2003).

Sample Selection

As the researchers' study was undertaken in Yemen, the population was four (4) fully-fledged Islamic banks operating in Yemen. 'Fully-fledged' implies that the banks are stand-alone Islamic banks separately incorporated and not merely Islamic windows. The decision was made to select only fully-fledged Islamic banks as it was reckoned that they would be more committed to adhering to Shari'ah principles, rather than Islamic windows which simply provide alternatives to interest products, but are still part of a conventional bank whose foundation does not rest on the principles of Shari'ah.

The population was narrowed down based on availability of annual reports on the internet. This led to a final sample of 4 Islamic banks in Yemen. They are as follows:

1. Islamic Bank of Yemen for Finance and Investment

2. Tadamon Islamic Bank

3. Saba Islamic Bank

4. Al-kuraimi Islamic Microfinance Bank

Research Instrument

The researchers adopted, the 'ideal ethical identity' checklist developed by (Haniffa & Hudaib, 2007) in order to determine the social reporting practices of Islamic banks in Yemen. The reason for adopting H&H (2007)'s checklist was because it contained a detailed list of items known as 'constructs' which Islamic banks ought to disclose. In addition, (Haniffa & Hudaib, 2007)'s study was one of two most recent studies on the disclosure patterns of Islamic banks (the other one is (Maali et al., 2003), and thus provided the most recent scholarship in the area of Islamic banks social reporting practices. The researchers adopted H&H (2007)'s checklist completely. An important note was the fact that (Haniffa & Hudaib, 2007) focused on the ethical identity of Islamic banks, and thus did not take into consideration the banks' activities effect on the environment which is an important part of social reporting. As the researchers' aim was to explore the social reporting practices of Islamic banks in Yemen, it was important to include a dimension dealing with the environment, which is an integral part of the social reporting process. To accomplish this, the researchers looked to (Maali et al., 2003) study which examined the social reporting practices of Islamic banks. The reason the researchers chose this study was because it was the only other one in the literature apart from (Haniffa & Hudaib, 2007) in recent times that examined the reporting practices of Islamic banks. (Maali et al., 2003) included an 'environment' dimension in their research instrument and this dimension had two items that Islamic banks were expected to disclose, and these are outlined as follows:

The amount and nature of any donations or activities undertaken to protect the environment, and

The projects financed by the bank that may lead to harming the environment.

This 'environment' dimension and its two 'constructs' listed above were inculcated into the 'ideal ethical identity checklist' under the 'Community' theme, as the environment is considered a part of the banks' stakeholders in the community.

Therefore, the checklist utilized by the researchers for the study consisted of 4 themes,

9 dimensions and 80 constructs. A copy of the checklist is presented in the appendix of the researchers' study

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