1.Introduction

Socio-economic justice is one of the important purposes in all societies[1] including Islam. However, every society has different strategy to pursue that objective. In Islam, those objectives only can be pursued if two elements are fulfilled, which are: ibadat (worship) and mu’amalat (mutual dealings).[2] The existence of those elements makes Islamic Economics is driven not only by human desires to fulfill his needs but also to comply with rules from Allah because in the hereafter Muslim must be accountable to Allah for all their actions, including in financial and commercial transaction.[3] According to Al-Quran and Hadits, the general principle of ibadat is “nothing is permitted unless covered by explicit or permission by Allah” while the general principle of mu’amalat is “everything is permitted unless that is explicitly prohibited by Allah’. The consequences of this principle is, Islamic Scholars are given wide range of freedom to use their knowledge to postulate Islamic Economic theory as long they follow the general rules in Al-Quran and Hadits of transaction namely prohibition of riba,gharar & maysir and haram business.

This essay will discuss  the values of Islamic Economics  to find out whether it offers a new socio economic value or not and how that values are translated into Islamic Banking and Finance. The examination will involving examination relevant Capitalism theory coined by Adam Smih, Socialism coined Karl Marx and the Socio-Market Economics (Germany approach). Further, the second part of this essay will found out how the socio-economic values of Islamic Finance is implemented in Islamic Finance and Banking (IBF) and to find out how resilience IBF during 2008 crisis and its continuity until now. This essay will stand with conclusion that Islamic Banking and Finance does provide new socio-economic value and viable option of financial and banking.

2. Does Islamic Finance Present New Socio-Economic Reading?

Hunts argue economists always vitally concern with practical, social, political and moral issues when postulating economics theory.[4] This postulation consequently makes every economic theory has two elements namely: ‘cognitive-scientific element’ and ‘moral element’. Cognitive-scientific element leads to the action of finding solutions while the moral element becomes a guide on how to limit the solutions that will be used .[5] Arguably, Islamic Economics is the only one economic system which has strong ‘moral-driven’ element because it is led not merely by a human intention but also by an  instruction to comply with Sharia (Islamic Law) which is the “corpus of moral and legal discourses.”[6] However, it does mean that all values in Islamic economics are a totally new value because those values also can be found scattered in other economic theories.

Corrupted lobbying practices of manufacturers merchant to the legislature is one of moral degradation in mercantilism era that was criticized by Adam Smith. Smith believed that corrupted practice must be stopped because it just benefited the wealthy and powerful people while neglected the poor and  the indigent rights.[7]  Therefore, in his capitalism theory, Smith promoted a widest opportunity to every individual to ‘pursue his own interest his own way’ and ‘bring both his industry and capital into competition’  as well as proposed relinquishment of state from directing private enterprise.’[8] The duty of government under capitalism is only to secure every individual is able to conduct their business and render their annual revenue in accordance with class of society he made, which are: the rent for landlord, the wages for labour and the profit of stock (capital) for entrepreneur.[9] In Smith’s concept, the aggregate endeavors of individual when conducting business will create the wealth of society and  the fair competition will lead to supply and demand which consequently creating automatic equilibrium on the market (the invisible hand).[10]  Islam is in the same view with capitalism in regard to protection of individual property, encouragement to work hard, competition, and to take risk in investment.[11] However, freedom to acquire and accumulate wealth is not unlimited. Work and investment are the only legitimate ways while gambling  and getting profit from any commercial transaction that does not need any effort to get it (masysir) are prohibited.[12]

Furthermore, in Islam, the role of  State is not just to secure business and market, but more importantly, it must be functioned as an institution to alleviate poverty by preventing an extreme income inequality.[13] Letting the market be monopolised by private interests will lead to inequality, insecurity, and conflict [14] Therefore, the State may institute any policy that is necessary for the restoration or attaintment of an equitable income distribution.[15] This features makes Islamic Economic theory is different with Capitalism which believes  only the market that is an effective tools to create distribution. Islam believes some resources that are benefited for society should be managed by the State rather than by the  individual. As narrated by Abu Dawud, moslem should be in partnership in three things: herbage, water and fire, which translated by Islamic scholars as natural resources. [16] Many scholars argue this feature makes Islamic Economics same with Socialism but it is not same. Marx’s socialism emerged as a response to class struggle between the burgeous who owns means of production and the vast majority of labor (proletariat).[17] Marx condemned the exploitation of labor in a capitalist system where the labor is paid lesser than the commodity that he had already produced.[18] This means, the labor is only perceived as a commodity under capitalist system which can create surplus for the burgeous if the cost of its production is pressed.[19] According to Marx, this condition can be solved not by relying to the market, but by  ‘social ownership’ and ‘democratic control of production’ which  can be reached through two phases  namely ‘socialism’ and ‘communism’.[20] Socialism is the transition phase from capitalism while ‘communism’ is the phase where the State would ‘wither away’ and the production will be owned by community. [21]

Islamic Economic theory recognizes the principle to humanize the labor as the Quran says that the wages are the ‘right’ of the labour and not a  righteousness from the employer.[22] The concept of ‘equal pay for equal work’ as well the principle to set a minimum wage that is ‘fair’ and in accordance with ‘living wage’ level are also acknowledged.[23] The relationship between the labor and employer should be based on the ‘collective bargaining’ as knowing in theory of contract. [24] However, unlike the socialism, Islamic Economic theory does not ignore the existence of the  market and the State to reach social justice, instead it recognizes the instrument named Hisbah, a state institution which acts as market inspector.[25] According to Ibn Taimiyyah, the role of Hisbah not only to control the price in the market but also to ensure the fair wages for the labor.[26] Further, Islam also encourages their follower to pay obligatory Islamic obligatory alm (zakat) and any other voluntary alms such as sadaqa or Islamic trustee (waqfs).[27] Taking into account that differences, it can be said that Islam has similar objectives with socialism in regard reward to labor and equal partnership however they are completely different in terms of the way how reach it. As Islamic Economics does not stand with Capitalism as well as Socialism, Nienhaus argues that Islam is compatible with the Social-Market Economy,[28] but arguably both are not.

Mureson postulates three main pillars of Socio-Market economy system namely: market economy, social order, and ecology.[29] Wrobel translates ‘market’ in this economic system as  a procedure to balance the domination of private enterprises in the market with the intervention of the State to establish fair competition, low inflation, and social welfare.[30] While the social order is implemented through the specific laws and institution carried by the state to channel the money from the private enterprises to the ‘social’ side of the system.[31] This concept is similar to Islamic Economic theory that puts the state as an authorized institution to canalize fund from zakah (obligatory alm) to the people in need. In Islam, the responsibility to the creation of social justice is located in the society (ummah), not in the State.[32]  However, the State is given authority to ensure that such distribution is conducted well and all citizens have a reasonable standard of living.[33] Further, in regard with ecology, Socio-Market economy emphasis the responsibility of human towards the environment which according to AbdelMajjid Najjar Islam also recognizes the importance to save and preserve the environment as one of the purposes of shariah (Maqasidh Syariah).[34] However, same with Capitalism, the Socio-Market economy is also operating interest in its financial system which according to Nienhaus this is the main different between Islamic Economics and Socio-Market Economics.[35] Arguably, it is not just interest that make difference between these economic systems. The prohibition to conduct illicit, as well as gambling business also must be taken into account.

Interest in Islam is translated as ‘riba’  or “unjustified enrichment”[36] Interestingly, the prohibition of interest is not merely the domain of Islam, because many religions, such as Hinduism, Judaism and Christianity, and philosophers also promote interest-free transaction in their teaching. Judaism prohibits a jewish to impose a rent interest to their jewish fellow, but  Jewish teaching still allows the imposition of interest to person outside Jewish society. Plato and Aristotle condemned interest because it flourishes cupidity into and degradate human being. However, Plato divides interest into types which are: interest in voluntary credit and involuntarily credit.[37] Plato gave room for the imposition of interest if there is a condition of  the retardation of payment in a case of involuntarily credit while Aristotle condemned the interest totally because the interest has distorted the true function of money as merely medium of exchange.[38]

What makes Islam different with another teaching is, Islam does not merely see prohibition of interest as  commercial matter, but it has greater objectives to create societal and human well being[39] based on  ‘Maqasih al-Shari’ah’ (the purpose of Shariah) to protec faith (din), self (nafs), intellect (‘aql), posterity (nasi) and wealth (mal). Whereas, according to Islamic sholars, riba is not  promotes even one of those purposes.[40] Therefore the  prohibition of riba in Islam cannot be negotiated as it is clearly stated in  Al-Quran, prophetic quote as well as consensus of Islamic scholars (fuqaha) throughout history.[41] According to scholars consensus interest is prohibited whether for consumption purposes, productive purposes, loans or personal, whether the borrower is government  or individual and whether the rate is low or hight.[42]

Therefore, it can be said  Islamic Economics shares the idea of balancing the market and the role of the State to create social justice with Socio-Market economic theory, however the prohibition of interest, illicit and the high risk business become the principal different between both of systems. Moreover, Islamic Economic theory has similarity in regard with professional work ethic and protection of individual property with Capitalism and appreciation to labor as well as the business relationship with the Socialis

3.Islamic Economics Values in Islamic Finance and Banking and Its Viability

Having identified the values of Islamic Economy in Part 2, arguably the translation of Islamic Economic theory in Islamic Banking and Finance (IBF) is lying in the form of: a) Prohibition of Interest; b) Profit and Loss Sharing system; c) Prohibition of Debt Finance and d) Prohibition of illicit and activity involving speculation (haram, gharar, masysir transaction).[43] Profit-Loss Sharing System (PLS) is an alternative given by Islamic Finance to change interest-based products in conventional banking. PLS is emanated through Musharakah (Join Venture Profit & Loss Sharing) and Mudharabah (Trustee Profit Sharing). In Musharakah, the bank and the customer agree to fund one business product with certain proportionof financial profit and losses that should be borne together.[44] While in Mudharabah, the bank sponsors one of its business owner which has potential business proposal and skill but does not has money. In this scheme the bank gets benefit from the experience and skill of the business owner and the business owner get benefit from the fund invested to his business. If the there is a loss then the bank loss its money. For both of those transaction should avoid haram, gharar transaction[45]

What can be drawn from those schemes is, every transaction in IBF is promoting  equality between the capital owner and the entrepreneur. The entrepreneur and the business owner/customer are encouraged to participate in their transaction [46] which in this sense reflecting the emancipation and individuals in the society.[47] While in regard with ‘prohibition of debt finance’ it is relevant with how Islam looking the money. In Islam, money does not have instrinsic value, it is merely a medium of exchange and a store of value, therefore it cannot be sold or rented to make  a ‘surplus value by itself’.[48] Further, money should be backed by an asset and therefore Bond or fixed-income securities cannot be used under in IBF. Islamic scholars then created instrument namely ‘Sukuk’ which is a collective certificate of financing identifiable assets. Unlike Bond which indicates a debt of the business owner, Sukuk represents the level co-ownership of assets permitted under Islamic law.[49] The principles of PLS and asset-based financing according to International Monetary Fund (IMF) can help promote better risk management by both financial institution and their customer and discourage credit boom as that already happened in world crisis in 2008.

According to Beck, although IBF is less profitable then conventional bank, but it had  higher capitalization, higher liquidity reserves and more stable compared to its conventional counterpart during 2008 crisis.[50] Zehri at al’s research showed that the main reason IBF stability are: 1) an absence of artificial money that often driven by interest charging; 2) PLS principle that makes the convergence between bank and depositors, bank and investors.[51] While according to Islamic Financial Service Board (IFSB) Report 2016, up to the end of 2015 the overall asset of global Islamic banking are about  approximately USD 1.57 trillion, this shows the double digits growth rates of IBF after 2008 crisis.[52]  IMF is also confidence that IBF has potential to contribute higher in economic growth because of the large segments of the Muslim population that are still underserviced by conventional finance.[53] However, Asutay argues, the resilience of IBF is ‘overly exaggerated’ as in fact IBF was still affected by the crisis 2008 especially for its  Murabahah (mark-up priced financing products) which has similar nature with conventional product. Therefore he concluded that the ‘resilience’ of IBF during 2008 was more influenced by the ‘internal’ rather than ‘external factors’.[54] This statement is also supported by Beck which argues that the resemble product of IBF with conventional makes  IBF only slightly outperformed conventional system. Arguably, this condition shows that IBF is still struggling to create and market  its ‘authentic’  products. If this condition is not overcame the IBF will not resistance if another global crisis come.

Moreover, Beck, Zehri and IMF and IFSB also point out that IBF certainly  has regulatory and supervisory challenges that will affect its viability in the future.[55] Islamic banks subject to ‘equity investment risk’ as their assets are made up by physical investments that the return are uncertain.[56] Mirrored to 2008 crisis, apart from hight rate of interest and gigantic speculation of Mortgage Backed Securities (MBS), the crisis was also triggered with the easy initial terms to get a credit.[57] Arguably, this condition can also attack IBF if the assessment of business feasibility of a business project is not applied carefully following a high and reasonable prudential standard. IMF addresses this potential risk may also come from supervisor of Islamic Banking which do not have the capacity to oversee the cross sectoral approach that is involved in Islamic Banking activities according to mutual fund-like activities.[58] Further, in term of liquidity, although IBF tends to hold high levels of liquidity compare to conventional bank, but the Islamic bank lacks of Sharia’ah compliant and high-quality liquid assets (HQLA). This condition tends make Islamic banks hold a higher share of cash, which can affect their profitability.[59] What can canvassed from this condition is, the viability of IBF in the ensuing year may be threatened if the IBF does not build its own prudentiality, risk assessment as well as sharia-compliance that must be  compatible with its uniqueness. In this case the regulation on conventional banking and finance cannot be applied to IBF as both of these system are different in nature.

4.Conclusion

Islamic Economic theory shares some socio-economic values with Capitalism, Socialism and Socio-Market Economy system. In regard with Capitalism it has similarity in terms of  work encouragement and protection of private ownership, while with Socialism it shares the same value in regard of reward to partnership and labor. Islamic Economic theory may be comparable with Socio-Market Economy in regard with social equality and socio-justice. However, it does not indicate that Islamic Economics is same with Socio-Market Economy because there are some principle transactions such as interest-based transaction, high risk transaction and illicit (haram) transaction that are still exist in the Socio Market Economy. Therefore, it can be said that Islamic Economic theory offers new socio-economic reading in term of social justice, private ownership security, encouragement to work hard, reward to partnership and labor, and transaction based on shariah. Those values  fall within  the ambit of Maqasidh Syariah (the purpose of Shariah). Islamic Economics’ values  and are translated to IBF through Profit and Loss Sharing Transaction and Prohibiton of Debt Finance. In regard with with viability, IBF has already succeed in passing 2008 crisis because of its its interest-free system and profit and loss sharing principle. Further, the general trend of its growth is also positive.However, its resistance only slightly outperformed the conventional financial system. This is caused by  the products of IBF at that time that was not reflected the primary values of IBF such as Murabaha. Further, IBF has faced challenged in regulatory, supervisory and sharia-compliance in IBF to discipline the system. Regulation regarding prudentiality is needed to assess any mutual-fund business transaction while the sharia-compliance is needed to ensure the IBF  create ‘authentic’ sharia products. IBF can be a new viable option if its moral value regarding ‘participatory in economy’ which is translated to Profit and Loss Sharing-based product can be marketed well to the public and is attached with the good governance and regulation to improve risk-assessment management.

[1]  Umar Chapra, ‘The Nature of Riba in Islam’ (2006) 2 The Journal of Islamic Economics and Finance (Bangladesh) 7

[2] Iqbal Munawar and Molyneux Philip, Thirty Years of Islamic Banking (Palgrave Mcmillan, 2005) 6

[3] Umar Chapra, ‘ Islam and Economic  Challenge’ (UK:Islamic Foundation 1992) 6-9

[4] EK Hunt, History of Economic Thought (2^nd edn, ME Sharpe 2002) xviii

[5] Ibid

[6] Salah El-Sheikh, ‘The Moral Economy of Classical Islam: A Fiqhieconomic Model’ (2012) 98 The Muslim World 16

[7] Heinz Lubasz, ‘Adam Smith and The ‘Free Market’ Stephen Copley and Kathryn Sutherland

(ed), Adam Smith’s Wealth of Nations : New Interdisciplinary Essays (Manchester University Press, 1995) 53

[8] Ibid 56

[9] Ibid 57

[10] Ibid 63

[11] Hossein Askari  and  Roshanak Taghavi, ‘The Principle Foundations of an Islamic Economy’ (2005) 58 BNL Quarterly Review 187

[12]  El-Sheikh (n6)

[13] Askari and Taghavi (n11)

[14] Ibid

[15] Ibid, ‘It means to taking counsel with the knowledgeable

[16] Abu Dawud, Sunan Abi Dawud, (Bayrut: Dar al-Kitab al-Arabi) 295

[17] Hunt (n1) 205-215

[18] Ibid

[19] Ibid

[20] Richard E Ericson, ‘The Classical Soviet-Type Economy: Nature of the System and Implications for Reform’ (1991) 5 Journal of Economic Perspectives 11

[21] Ericson (n20)

[22] Qur’an (95:06),  ‘those who believe and perform honorable deeds (good work) . . . their earnings will never be withheld from them” (95: 06).

[23] Iftikhar Ahmad, ‘Religion and Labor: Perspective in Islam’ (2011) 14 WorkingUSA The Journal of Labor and Society 589

[24] Ibid

[25] Ibid

[26] Ibid

[27] Konrad Adenauer Stiftung, ‘Islamic Economic Thought and The Social Market Economy Berling –Abu Dhabi- Ankara’ [2010]  Konrad Adenauer Stiftung 1

[28] Volker Nienhaus, ‘Fundamentals of An Islamic Economic System Compared To The Social Market Economy A Systematic Overview’ (2010) 11 Konrad Adenauer Report 75

[29] Stefan Sorin Muresan, Social Market Economy The Case of Germany (2014 edn,Springer 2014) 159

[30] Ralph M. Wrobel ‘Social Market Economy as Alternative Approach of Capitalism after the Financial and Economic Crisis’ (2011) 12 Economic and Environmental Studies Vol. 12, No.1 (21/2011)  47

[31] Muresan (n22) 165

[32] Askari and Taghavi (n11)

[33] Ibid

[34] Mehmet Asutay and Astrid Fiona Harningtyas, ‘Developing Maqasid al-Shari’ah Index to Evaluate Social Performance of Islamic Banks: A Conceptual and Empirical Attempt’ (2015) 1  International Journal of Islamic Economics and Finance Studies 5

[35] Konrad Adenauer Stiftung (n26)

[36] El-Sheikh (n6)

[37] Barry Gordon, ‘Lending At Interest: Some Jewish, Greek, and Christian approaches, 800 BC-AD 100’ (1982) 14 Duke University Press 406

[38] Ibid

[39] Asutay and Harningtyas (n33)

[40] Asutay and Harningtyas (n33)

[41]Mu’tamar al- Fiqh al-Islami held in Paris in 1951 and in Cairo in 1965, and the OIC and Rabitah Fiqh Committee meetings held in Cairo and Makkah 1985 and 1986

[42] M. Umer Chapra, ‘The Nature of Riba in Islam’ (2006) 2 The Journal of Islamic Economics and Finance (Bangladesh) 7

[43] Adil Abdul Salam Ashhoob and Jumah  Ali Asoessi Darbouk, ‘Islamic Finance: An Effective & Reasonable Option’ (2015) 6 IOSR Journal of Economics and Finance 17

[44] Aisyah Abdul-Rahman and Shifa Mohd Nor, ‘Challenges of Profit-and-Loss Sharing Financing in Malaysian’ (2016) 40 Malaysian Journal of Society and Space 39

[45] Ibid

[46] Abdul-Rahmand and Nor (n42)

[47]  Asutay and Harningtyas (n33)

[48] Mudhakkir Abdul, ‘The Concept of Money in Islamic Economics’ Linkedin, 6 January 2016 <https://www.linkedin.com/pulse/concept-money-islamic-economics-mudhakkir-abdul-cife- > accessed 10 January 2016

[49] Konrad Adenauer Stiftung (n26)

[50] Thorsten Beck, Asli Demirguc-Kunt and the others, ‘Policy Research Working Paper 5446 Islamic vs Conventional Banking Business Model, Efficiency and Stability’ (2010) World Bank < http://documents.worldbank.org/curated/en/482731468333056240/Islamic-vs-conventional-banking-business-model-efficiency-and-stability> accessed 13 January 2017

[51] Chokri Zehri, Asma Abdelbaki and the others, ‘Effects of the current financial crisis on Islamic Banks Compared to Conventional Banks’ (2012) 7 Banks and Bank System 83

[52] Islamic Financial Services Board,’Islamic Financial Services Industry Stability Report 2016’ [2016] Islamic Financial Services Board <file:///C:/Users/B4051993/Islamic%20Finance%20Essay/Islamic%20Stability%20Report.pdf> accessed 10 January 2016

[53]  Alfred Kammer and the others, ‘Islamic Finance: Opportunities, Challenges, and Policy Options’ (2015) International Moneatary Funds (IMF) < https://www.imf.org/external/pubs/ft/sdn/2015/sdn1505.pdf> accessed 10 January 2016

[54] Kammer (n52)

[55] Beck (n49)

[56]  Kammer (n52)

[57] Nawal Hussein Abbas El Hussein, ‘Islamic Finance: Is It Viable Option to Restrain Financial Crisis?’ (2013) 5 Interdisciplinary Journal of Contemporary Research in Business 576

[58] Kammer (n52)

[59] Ibid

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