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The challenge of bridging the expectations gap

Honest communication between customer and institution is key when linking Islamic finance and socially responsible investing

Ethical differences
Image Credit: Hadrian Hernandez/Gulf News Archive
When labels like “Islamic,” “responsible,” and “sustainable” are associated with finance,they trigger expectations of ethical differences from the mainstream. When it comes toIslamic finance and socially responsible investing, the gap between expectations andpractice presents a significant challenge.
Gulf News

Dubai: With the increased profile of Islamic banking globally, the GCC Islamic banking community is well positioned to build on a leadership role versus other potential competing centres such as Malaysia, Iran or even the UK.

GCC countries collectively now account for more Sharia-compliant financial assets globally than any other region or country. GCC Islamic banks have also demonstrated their ability to be more innovative in terms of product development and provision of services as they compete for business with conventional banks.

However competition in the GCC has also resulted in a fragmented Islamic finance industry with most local institutions remaining relatively minor players on a global scale. With their relatively lower asset bases they have also seen stiff competition in their own backyard from some of the largest international banks looking to tap the market.

When labels like "Islamic," "responsible," and "sustainable" are associated with finance, they trigger expectations of ethical differences from the mainstream. When it comes to Islamic finance and socially responsible investing (SRI), the gap between expectations and practice presents a significant challenge.

Anecdotal evidence suggests that, rightly or wrongly, some of the expectations triggered by "Islamic" finance are no lending money on interest, no financing of "sin" industries (for example gambling), profit and loss sharing, asset and enterprise, microfinance, small and medium sized enterprise (SME) finance, poverty alleviation, and environmental sustainability. Perhaps the underlying theme is profit sharing, doing good and avoiding harm to society and the environment.


In practice, other than refusing to finance "sin" industries, these expectations are hard to meet. Despite the expectation of profit sharing, most of the financing in the Islamic financial sector is debt based, where the form of financing is changed to that of a sale or a lease without necessarily changing its economic substance. For example, payment schedule and terms and conditions in home financing in the Islamic financial sector may look very similar to, if not the same as, those in a conventional mortgage.

This gap between expectations and practice produces sarcastic media coverage—for example, Don't Call It Interest by Richard C. Morais, Forbes, 2007) and How Sharia-Compliant Is Islamic Banking? (John Foster, BBC News, 2009). Such academic research papers as Incoherence of Contract-Based Islamic Financial Jurisprudence in the Age of Financial Engineering (Mahmoud A. Al Jamal, 2007) also raise similar issues.

Regarding doing good and avoiding harm to society and environment, some argue that the job of financial institutions is to maximise profit for their shareholders and that profitable business leads to prosperous society. If shareholders want to do something charitable, they can do so in their private lives.

A counter-argument is that to use the "Islamic" label, financial institutions need to go beyond changing the form of financing and earn their profits while actively doing something positive. For example, Islamic banking should focus on SMEs rather than high-net-worth individuals, and Islamic project financing should push for fair treatment of construction workers and efficiencies in energy, waste, water, and carbon emissions.

The catch here is that for such positive pursuits to work, customers also have to do their part.


Similarly, if customers want institutions that offer Islamic financial services to pursue socio-economic goals, they should be willing to share any additional risks and costs. This gap between expectations and practice is not unique to Islamic finance.

In 2004, in a research paper titled Socially Responsible Investing, Paul Hawken found that "the cumulative investment portfolio of the combined SRI mutual funds is virtually no different than the combined portfolio of conventional mutual funds." In other words, the expected ethical difference was blurred.

Perhaps the titles of these two biting articles published in 2010 summarise their content: 100 Best Corporate Citizens? What a CROck! by Marc Gunther and When Pigs Fly: Halliburton Makes the Dow Jones Sustainability Index by R.P. Siegel. Paul Hawken also noted in 2004 that "Muslim investors may be puzzled to find Halliburton on the Dow Jones Islamic Index fund."

How to deal with this gap between expectations and practice? Do financial institutions mislead customers with labels like "Islamic," "responsible," and "sustainable"? Or do customers have unrealistic expectations? Is it possible to bring the practice and expectations closer?

There is no easy answer to these questions. Having said that, one thing that could help to narrow the gap between expectations and practice is honest communication of what exactly is the ethical proposition so that when someone takes "a small step" toward ethical ideals, it is not criticised for not being "a giant leap" but appreciated for what it is.

(Usman Hayat, CFA, Director of Islamic finance & ESG at CFA Institute and Domluke Da Silva is CFA Executive Committee member of the local CFA Emirates Society)