Role of Islamic Finance in the Transformational Change
BismillahiRahmaniRahim. In the name of Allah, the most Merciful and Benevolent.
Assalamualaikum warahmatullahi Wabarakatuh. May peace be upon you.
Ladies and Gentlemen – a very good afternoon to all.
- It is always a pleasure for me to be here in Oxford where I have many fond memories. One of these memories, which has relevance in the context of this Roundtable, is that of having regular interaction and discussions with scholars and intellectuals. The acquisition of knowledge is an endless pursuit. The sharing of the knowledge acquired is an equally unending exercise, which is why I look forward to this annual SC – OCIS Roundtable series where I never fail to be impressed by the commitment shown by the participants to enhance the development of Islamic finance through the powers of their collective knowledge.
- The theme of this year’s Roundtable “Seeking Sustainability: Role of Islamic Finance in the Transformational Change” is much broader in scope than those of previous Roundtables, and is one that I find highly fascinating. I believe the theme requires deep reflection and deliberation on reshaping the overall landscape within which Islamic finance operates. It also requires discussions on elevating the role of Islamic finance in influencing or even driving the transformation towards a more stable and sustainable environment.
- Debate and discussion on the issue of sustainability have been a frequent agenda in various forums in recent years as the world continues to face widespread environmental degradation and inequitable distribution of wealth and resources. These issues have posed significant challenges for governments and policy makers in formulating economic and social development policies.
- Some have argued that the global financial system, which is based on the free market economy and places consumerism as a primary measure for progress and prosperity, has failed. Further, this argument contends that the model of the current financial system has not only led to the collapse of financial markets but has also resulted in adverse social and environmental consequences as well as misallocation of resources due to the sole pursuit of profitability. These negative consequences include climatic imbalances leading to global warming as well as food and water shortages, and socio-economic issues such as child labour and persistent poverty.
- According to the World Bank, 14.5% of the world’s population in 2011 lived in poverty, defined as those with daily income of USD1.25 or less. The distribution of the poor, by region, ranged from a high of 46.8% in Sub-Saharan Africa to a low of 0.5% in Europe and Central Asia. This substantial disparity among regions represents yet another challenge in addressing the issue of sustainable, equitable and inclusive global economic growth. In 2014, the numbers remain relatively unchanged with over one billion people worldwide still living in extreme poverty.
- If the model of the current financial system is to be transformed to one that facilitates economic growth while ensuring sustainability, it is imperative for financial regulators and policy makers to devise strategies that achieve mutually reinforcing outcomes that fulfil both objectives. Nevertheless, in developing these strategies, it is necessary to first identify and understand the challenges posed by current practices that act as a serious hindrance in achieving sustainability. While there are a number of these challenges, I wish to highlight three this afternoon – the overreliance on debt; the dominance of self-interest; and the lack of values-based leadership – which I hope will help in setting the tone for our deliberation this weekend.
Overreliance on Debt
- First, the overreliance on debt. The OECD states that “high debt levels can create vulnerabilities, which amplify and transmit macroeconomic and asset price shocks”. They also “hinder the ability of households and enterprises to smooth consumption and investment and of governments to cushion adverse shocks”. In the book House of Debt, an analysis of the recent recession in the US suggests that “the real cause of the post-crisis slump was not the damage to the banks, but the run-up in household debt that came before, which became an anchor on consumption when house prices subsequently collapsed” .
- The leveraging effect of debt exacerbates the negative impact on the financial markets and the economy during periods of downturn. Overreliance on debt will likely cause severe disruptions to the market as well as to socio-economic stability and should therefore be addressed if we are to strive towards greater sustainability in the financial system. The concern in respect of debt supports Islam’s view that debt is strongly discouraged and that an equity-based model or contract is preferred as it is consistent with the maqasid al Shariah or objectives of Shariah.
- Islam’s abhorrence of debt is premised, among others, on the likelihood that access to debt may induce a person to spend beyond his means. It follows then that when a person spends in accordance with his level of wealth or income, the probability of being in financial distress is significantly mitigated and he is therefore able to sustain his lifestyle. By extension, this line of argument can be applied to the broader financial system. Furthermore, the risk- sharing element of an equity-based contract promotes a more equitable relationship between the contracting parties that collectively becomes a more sustainable arrangement.
Dominance of Self-interest
- Second, the dominance of self-interest. The root cause of most of the recent financial crises is manifested in the steadfast attachment to self-interest which becomes the key driver of economic behaviour, with profit being the primary consideration of most decisions.
- In my view, the management and governance of financial affairs should not be dominated by the parochial need to maximise financial returns and enhance shareholder value. Decisions on financial returns must also fulfil the obligation and responsibility to ensure that actions and outcomes do not threaten society, the environment and future generations.
- Islam in fact views the management of the economy to be subservient to humankind and should be administered responsibly and prudently, under the concept of khalifah or human stewardship. Greed and exploitation could thus be avoided, and decisions would be guided by values that could reap rewards even into the distant future. As I had posited during my address at the Khazanah Megatrends Forum in Kuala Lumpur last year, “if we accept the notion that we are trustees, rather than ultimate controllers, over the resources in existence today, and that we owe an implicit duty for preservation and prudence, then the ethos of sustainability should be at the heart of our pursuit of growth”.
The Lack of Values-Based Leadership
- Third, the lack of values-based leadership. In view of short term, financial-linked key performance indicators, many business leaders traditionally view their role in instilling positive values within their organisations, at best, as secondary. For a few, this role may even be considered a distraction. A compromise on these business values is an inevitable result when profit maximization is clearly and singularly placed as the top priority in such organisations.
- Complicating the relationship between business values and profits within an organisation is its management culture, which is essentially moulded by either rules-based or values-based considerations. Rules-based, being a legalistic orientation, typically leads to mere obedience to the letter of the law, and therefore may result in inattention towards achieving the public good, intentionally or otherwise.
- On the other hand, a values-based approach prescribes to a set of ethical standards, moral principles as well as religious and cultural beliefs that propagate the need to take into consideration both the commercial and social outcomes of a decision. Values-based leadership requires looking beyond rules and regulations in order to achieve the public good.
- Islamic finance incorporates within its structure the code of akhlak or ethics, as clearly spelt out in the Quran and Hadith. A Hadith related by Abu Said states that, “the truthful and trustworthy businessman will be in the company of Prophets, saints and martyrs on the Day of Judgment”. Values-based elements such as adherence to strong ethical and moral values therefore are already inherent in Islamic finance.
- It is encouraging to note that an increasing number of commercial enterprises are now placing non-financial outcomes as an important part of the key performance indicators for management. As Bob McDonald, former Chairman, President and CEO of Procter & Gamble, said, “companies must do well to do good and must do good to do well”.
Transformational Change for Sustainability
- The pursuit of profit has been prevalent since early civilisation. Allow me to quote Lü Bu-wei, a Chinese Prime Minister in 246 B.C. under Emperor Ying Zheng, who provided an interesting observation on this subject:“In making judgments, the Early Kings were perfect, because they made moral principles the starting point of all their undertakings and the root of everything that was beneficial. This principle, however, is something that persons of mediocre intellect never grasp. Not grasping it, they lack awareness, and lacking awareness, they pursue profit. But while they pursue profit, it is absolutely impossible for them to be certain of attaining it.” – Lü Bu-wei 246 B.C., Chinese Prime Minister under Emperor Ying Zheng
- We are now living in an era where the crises we face arise, to a large extent, from the decline in values, morals and ethics that has consequently led to economic, social and ecological imbalances. Islam emphasises that values such as equitability and the proper and efficient allocation of resources, and not merely financial returns, be central to any economic decision. Another Hadith refers to the prohibition on hoarding for the purpose of raising prices. It is through this proper recognition and adoption of values that the motion for sustainable development could and should be set.
- Moving forward it is imperative to find long-term solutions that will drive both growth and sustainability by taking into consideration the well-being of society, economic prosperity and the environment. In other words, we should strive for solutions that address present needs without endangering the welfare of future generations. We should seek solutions that provide equitable outcomes without compromising ethical and moral values.
- Islamic finance can and ought to offer a model that address these needs; where the fiduciary responsibility of institutions includes their role as khalifah; where risks and returns are shared equitably; and where a key objective is achieving the public good. Not only are values incorporated into the decision-making process but social and developmental objectives are also being advocated. The ability of Islamic finance to meet international prudential standards and investor protection expectations is also a crucial and compelling factor to institutionalise it into the transformational change of the global financial industry.
- In conclusion, I would like to encourage everyone here to take this excellent opportunity to deliberate constructively on how Islamic finance could transform the global financial industry by imbuing good values to achieve sustainability. The ideas and recommendations from the discussions at this Roundtable could be taken back to your respective organisations where they could be shared and further developed with relevant stakeholders and, Insha-Allah, adopted for implementation. I wish everyone a fruitful and rewarding weekend.